Take full advantage of tax relief – annual and lifetime limits

Pensions are a highly tax-efficient form of saving, and if possible you should take full advantage of funding your pension contributions to the maximum allowable. You receive tax relief on contributions that you pay into your pension. Tax relief means some of your money that would have gone to the Government as tax goes into your pension instead. You can put as much as you want into your pension, but there are annual and lifetime limits on how much tax relief you get on your pension contributions.

Subject to Income Tax

Any contributions you make over this limit will be subject to Income Tax at the highest rate you pay.

However, you can carry forward unused allowances from the previous three years, as long as you were a member of a pension scheme during those years.

But there is an exception to this standard rule. If you have a defined contribution pension, the annual allowance reduces to £10,000 in some situations.

From 6 April 2016, the £40,000 annual allowance reduced if you have an
income of over £150,000, including pension contributions.

Money Purchase Annual Allowance (MPAA)

In the tax year 2016/17, if you start to take money from your defined contribution pension, this can trigger a lower annual allowance of £10,000 (the MPAA). That means you’ll only receive tax relief on pension contributions of up to 100% of your earnings or £10,000, whichever is the lower.

Whether the lower £10,000 annual allowance applies depends on how you access your pension pot, and there are some complicated rules around this.

Announced as part of the Autumn Statement 2016, the MPAA will be reduced from £10,000 to £4,000 and come into force from April 2017.

This announcement will affect taxpayers (employees and self-employed) who have withdrawn amounts from their pension fund and then want to top the fund up again. The £10,000 limit was introduced in April 2015.

The Chancellor, Philip Hammond, said the decision was taken ‘to prevent inappropriate double tax relief,’ and the Government would consult on further details for the plans.

In a consultation released alongside the Autumn Statement, the Government says: ‘The Government believes that an allowance of £4,000 is fair and reasonable and should allow people who need to access their pension savings to rebuild them if they subsequently have opportunity to do so.

‘Importantly, however, it limits the extent to which pension savings can be recycled to take advantage of tax relief, which is not within the spirit of the pension tax system. The Government does not consider that earners aged 55 plus should be able to enjoy double pension tax relief i.e. relief on recycled pension savings.’

This change will impact on those individuals who may have needed to withdraw funds unexpectedly and then want to top them up when their circumstances change.

Defined contribution pensions

The existing lower annual allowance of £10,000 only applies to contributions to defined contribution pensions. So, if you also have a defined benefit pension (this pays a retirement income based on your final salary and how long you have worked for your employer and includes final salary and career average pension schemes), you can still receive tax relief on up to £40,000 of contributions a year.

For example, if you earn £20,000 a year and you contribute £8,000 to your defined contribution pension for the tax year 2016/17, you’ll receive tax relief on these contributions, plus you can still receive tax relief on up to £12,000 of contributions to your defined benefit pension.

If you earn £50,000 a year and you contribute £12,000 to your defined contribution pension for the tax year 2016/17, you’ll receive tax relief on just £10,000 (and the other £2,000 will be subject to Income Tax). In addition, you can contribute up to £30,000 to your defined benefit pension and claim tax relief on this.

Tax relief if you’re a non-taxpayer

If you are not earning enough to pay Income Tax, you can still receive tax relief on pension contributions up to a maximum of £3,600 a year or 100% of earnings, whichever is greater, subject to your annual allowance. For example, if you have relevant income below £3,600, the maximum you can pay in is £2,880, and the Government will top up your contribution to make it £3,600.