It’s never too early to start thinking about financial planning, especially when it comes to your retirement – whether that’s researching the options available for you, or even opening up an ISA or pension pot.
For many of us, the latter is something we are automatically enrolled into through our workplace. This includes a contribution from your employer each month, alongside the deductions made from your monthly salary.
However, there are many different pension allowances out there – and these come with implications. You may not be aware of the different allowances, or understand things such as the amount you can contribute a year, or the total sum you can accrue in your pension pot.
While financial planning services are out there to guide and advise you, we’re going to focus on the pension annual allowance in this article.
What is the Pension Annual Allowance?
Put simply, it’s a cap on how much you can save every year, upon which you can earn tax relief. This is because the UK government spends billions of pounds each year on pensions tax relief.
The tax relief is paid on top of your pension contributions, and based on the highest rate of income tax you pay. Generally speaking, this can be anything between 20 and 45%, in England.
For this tax year (2021-22), the annual allowance is capped at £40,000 – or 100% of your income if you are earning less than £40,000 a year. Based upon the above percentages, this means that basic-rate tax payers (20%) would receive £8,000 of pension tax relief towards their pot, taking the full £40,000 as an example amount. At the other end of the spectrum, additional-rate tax payers on the 45% band, would get £18,000 of tax relief.
How is the Pension Annual Allowance applied?
The annual allowance is applied to your pension, or all of your combined pensions, should you have more than one pot that have not yet been consolidated.
Included in this allowance is the total amount paid in a tax year by you, or anyone else, as well as any increases in a defined benefit scheme in a tax year. These are known as pensions savings, which are measured against the annual allowance – meaning, any excess will have to be taxed. We will discuss this further in the ‘what if you go above the annual allowance?’ section.
What is the Money Purchase Annual Allowance?
You may face a lower annual allowance, called a Money Purchase Annual Allowance (MPAA), if you have started to withdraw money from your defined contribution pension. For this tax year, this is capped at £4,000.
There are certain situations where the MPAA will be triggered, including:
What if you go above the annual allowance?
Should you exceed the annual allowance in a year, you’ll no longer receive pension tax relief on the contributions over the cap. Not only that, but you’ll be faced with an additional tax bill, called the Annual Allowance Charge (AAC). This isn’t a sum of money that needs to be paid right away, and instead, the charge is added to the rest of your income for that tax year.
If you have gone above the allowance, there are plenty of tools out there – like this calculator on the gov.uk website – which will work out how much you’ve gone above the allowance. The excess amount will also need to be included on a Self-Assessment form.
