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Annual and lifetime limits

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.

Tax relief on your annual pension contributions
If you’re a UK taxpayer, in the tax year 2016/17 the standard rule is that you’ll get tax relief on pension contributions of up to 100% of your earnings or a £40,000 annual allowance, whichever is lower.

For example, if you earn £20,000 but put £25,000 into your pension pot (perhaps by topping up earnings with some savings), you’ll only get tax relief on £20,000.

Similarly, if you earn £60,000 and want to put that amount in your pension scheme in a single year, you’ll normally only get tax relief on £40,000

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 is now reduced if you have an income of over £150,000, including pension contributions.

The 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.

The main situations when you’ll trigger the MPAA are typically:

If you start to take ad-hoc lump sums from your pension pot

If you put your pension pot money into an income drawdown fund and start to take income

You will not trigger it if you take:

A tax-free cash lump sum and buy an annuity (an insurance product that gives you a guaranteed income for life)

A tax-free cash lump sum and put your pension pot into an income drawdown product but don’t take any income from it

You can’t carry over any unused MPAA to another tax year.

The 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.

How much can you build up in your pension?
A lifetime allowance puts a limit on the value of pension benefits that you can receive without having to pay a tax charge. The lifetime allowance is £1m for the tax year 2016/17. Any amount above this is subject to a tax charge of 25% if paid as pension or 55% if paid as a lump sum.

Workplace pensions, automatic enrolment and tax relief
Since October 2012, a system has been gradually phased in requiring employers to automatically enrol all eligible workers into a workplace pension. It requires a minimum total contribution, made up of the employer’s contribution, the worker’s contribution and the tax relief.

Balance of flexibility and security to suit your circumstances

If you are looking for a balance of flexibility and security to suit your circumstances, you could consider blending your retirement options. You don’t have to choose one option when deciding how to access your pension pot – you could set up a combination of options to suit you.

You can usually take up to 25% of your pension money as tax-free cash as you choose which options to take. But remember that with any option, tax benefits are subject to change and depend on your individual circumstances.

You can also keep saving into a pension, if you wish, and get tax relief up to age 75.

Which option or combination is right for you will depend on:

Your age and health
When you stop or reduce your work
Whether you have financial dependents
Your income objectives and attitude to risk
The size of your pension pot and other savings
Whether your circumstanes are likely to change in the future
Any pension or other savings your spouse or partner has, if relevant

Everybody’s situation is different, so how you combine the options is up to you.

You could choose to buy a guaranteed income for life with some of your pension money, while leaving some to provide a flexible income or cash lump sums when you need them.

Or, if you plan to ease into retirement, you may choose to take some money flexibly to start with, and then later buy an annuity to provide a guaranteed income.

Don’t forget, in addition, you can usually take up to 25% of your pension tax-free. This can be taken all in one go or over time, depending on the options you choose.

You could close your pension pot and take the entire amount as cash in one go if you wish. Normally, the first 25% (quarter) will be tax-free, and the rest will be taxed at your highest tax rate by adding it to the rest of your income. Once you’ve taken all the money, your pension will close and you won’t be able to make any further payments into it.

However, there are many risks associated with cashing in your entire pension pot. For example, it’s highly likely that you may be subjected to a significant Income Tax bill. Opting for this approach also means that it won’t pay you or any dependant a regular income, and without very careful planning, you could run out of money and have nothing to live on in retirement.

If you’re planning to put the money you take into savings or other investments, you should compare and think about how it will get treated for Inheritance Tax purposes. If you are considering taking your entire pension pot, you should first obtain professional financial advice to fully understand the impact on you and your financial situation.

Three quarters (75%) of the amount you withdraw is taxable income, so there’s a strong chance your tax rate would go up when the money is added to your other income. If you exercise this option, you can’t change your mind. Also remember, this option will not provide a regular income for you, or for your spouse or any other dependant after you die.

For many or most people, it will be more tax-efficient to consider one or more of the other options for taking your pension. Taking a large cash sum could reduce any entitlement you have to benefits now, or as you grow older – for example, to help with long-term care needs.

Cashing in your pension to clear debts, buy a holiday or indulge in a big-ticket item will reduce the money you will have to live on in retirement. Another consideration is that you might not be able to use this option if you have received a share of an ex-spouse’s or ex-civil registered partner’s pension as a result of a divorce, or if you have certain protected rights with your pension.

Your pension scheme or provider will pay the cash through a payslip and take off tax in advance (PAYE). This means you might pay too much Income Tax and have to claim the money back – or you might owe more tax if you have other sources of income.

Extra tax charges or restrictions might apply if your pension savings exceed the lifetime allowance (currently £1,030,000), or if you have reached age 75 and have less lifetime allowance available than the value of the pension pot you want to cash in.

If the value of your pension pot is £10,000 or more, once you start to take income, the amount of defined contribution pension savings on which you can get tax relief each year is reduced from £40,000 (the annual allowance) to a lower amount (called the ‘Money Purchase Annual Allowance’, or MPAA). The MPAA for 2018/19 is £4,000. If you want to carry on building up your pension pot, this option might not be suitable.