Pension annual allowance: what are the rules?

Understanding the rules around your annual pension contribution allowance can be hard to grasp so here’s a breakdown of some important things to know.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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For many of us, our only interaction with our pension is simply paying into it each month. But did you know you have an annual allowance that could affect your pension?

Let’s take a look at the different rules and break them down. This will make sure that you don’t get caught out.

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What is the pension annual allowance?

Your individual allowance is the maximum amount you can save in your pension pot within a single tax year before you have to pay further tax on any contributions.

In some cases, it is possible to carry over any unused annual allowance from the previous three tax years.

In the UK, the tax year runs from 6 April to 5 April. So the current tax year, during which you can put money into your pension, ends on 5 April 2022.

What is the current pension annual allowance amount?

Currently, the annual allowance is set at £40,000 per tax year.

This may sound like a lot. But as you progress through your career, your earnings will rise and you will likely find that your earnings will be high as you get closer to retirement.

Also, if you’re self-employed or have your own business, maximising pension contributions and using up your yearly allowance can be a great way to keep more of your money and pay less tax.

Does the annual pension allowance change based on income?

This is where things get a little more complicated. If you’re a high-income earner, you will have a reduced (‘tapered’) pension allowance during the tax year.

So this means you’ll have a lower allowance if both:

  • Your ‘threshold income’ is over £200,000 (threshold income broadly means your net income for the year, so it’s any taxable income less certain specific allowances)
  • Your ‘adjusted income’ is over £240,000 (adjusted income refers to using your net income and then adding in any pension contributions from you or your employer)

The tapering means that if you breach these thresholds, your annual pension allowance reduces by £1 for every £2 your earnings are over £240,000. The maximum reduction is £36,000, which would leave you with a potential £4,000 maximum allowance.

Understanding this and working it all out can be quite a headache. It’s why a lot of people have unknowingly gone over their allowances since this tapered allowance came into play. If you think this could affect you, then it might be worth seeking professional advice from a financial adviser for your pension.

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How many people go over their allowance?

HMRC has issued figures relating to private pensions for the year 2018/19. They show that 47,880 people went over their pension allowance.

This is four times more than the number who exceeded the limit before the tapered annual allowance began in 2016/17.

Sarah Coles, personal finance analyst at Hargreaves Lansdown explains the figures: “The hideous complexity of planning pension contributions when you’re on the cusp of the tapered annual allowance helped push almost 50,000 people over the annual allowance in 2018/19. The freezing of the annual allowance means we’re likely to see that number continue to climb.

“The number of people being caught out by the pensions annual allowance jumped when the taper was introduced back in 2016/17, and has been rising ever since. The number of breaches which were paid for through schemes more than doubled in the year to 2018/19.”

How do I make sure I stay within my annual pension allowance?

This may not be an issue that affects you right now. But it’s something to be aware of because it could impact your pension in the future.

If you think that these rules could influence your situation, then it’s important to try and get some guidance.

Whether you’re close to retirement or it’s years away, proper financial planning and tracking your finances can help to prevent you from breaching your allowances. Tax rules can change, so it’s important to at least keep an eye on things and make sure you plan accordingly.

Please note that tax treatment depends on the specific circumstances of the individual and may be subject to change in the future.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

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