Tax relief on pension contributions

Annual and lifetime limits to consider
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 2015/16 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 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 April 2016, the £40,000 annual allowance will be reduced if you have an income of over £150,000, including pension contributions.

The Money Purchase Annual Allowance (MPAA)

In the tax year 2015/16, 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 lower.

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

As a basic guide, the main situations when you’ll trigger the MPAA are:

  • 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

A lifetime allowance puts a top limit on the value of pension benefits that you can receive without having to pay a tax charge.

And you won’t 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.

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 top limit on the value of pension benefits that you can receive without having to pay a tax charge. The lifetime allowance is £1.25 million for the tax year 2015/16 (falling to £1 million in April 2016). 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 is being 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.

Is it time to review your retirement plans?

These reforms present people with an exciting opportunity to take control of their pensions like never before, but the reforms highlight the need to obtain professional financial advice to consider your overall position. Although it may seem counter-intuitive, accessing your pension fund in many cases may be the last asset you call on, given the tax-efficiencies. To review your situation, please call us or use the contact form by clicking here – we look forward to hearing from you.

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