Pension limits and taxation

Pension limits and taxation can be a complicated and a financially technical subject. With numerous government changes over the past few years we have seen these limits reduce substantially and thus more and more people are now affected.

We strongly recommend you attend one of our workshops where we can fully explain in more detail how you may be affected and what you can do about it.

However, if you think you need immediate help to discuss your own personal circumstances, please contact:

The information below should only be used as information and guidance.

Tax Limits

HMRC limits the tax efficiency offered by pensions in two ways:

    1. The annual allowance (AA) – limits the value of contributions that can be made into your pension(s) before a tax charge is applied
    2. The lifetime allowance (LTA) – limits the total value of your pension savings at the point of drawing the pension, before a tax charge is applied

Definition of Annual Allowance

  • The standard annual allowance is £40,000*
  • You may have a tapered annual allowance if your income exceeds certain thresholds (see below)
  • It may be possible to carry forward unused annual allowance from up to the 3 previous tax years
  • For defined contribution savings, the annual allowance applies to total contributions during the year
  • For defined benefit savings, a formula is applied to calculate the value of the increase in pension entitlement
  • Your annual allowance will be lower than £40,000 if your income exceeds certain thresholds
  • This is referred to as the tapered annual allowance
  • If your total taxable income in a tax year exceeds £200,000
  • Your total income plus AVC contributions and DB accruals exceeds £240,000, your annual allowance will be reduced
    • May apply to you if your total taxable income exceeds £200,000
    • This figure is referred to as your ‘threshold income’
    • Total taxable income could include:
      • Salary and bonus (note that bonus deferral is no longer available)
      • Commission (and all other pay elements)
      • Any rental income you receive
      • Interest on savings
      • Dividends on shares
      • Certain state benefits
      • Pension income
    • If your total taxable income exceeds the ‘threshold income’ of £200,000 you will need to calculate your ‘adjusted income’
    • This is done by adding employer and employee pension contributions to your taxable income
    • If your adjusted income exceeds £240,000, your annual allowance will be reduced
    • If your adjusted income is between £240,000 and £312,000 you may not know your tapered annual allowance until after the end of the tax year
  • Annual allowance is reduced by £1 for every £2 that ‘Adjusted Income’ exceeds £240,000, subject to a minimum Annual Allowance of £4,000
  • Paying an annual allowance charge
    • A charge only applies once you have exceeded the current years AA and any carry forward available from the 3 previous years
    • Only contributions in excess of your available AA will incur an AA charge
    • The AA charge is calculated at your marginal rate of income tax
    • If your AA charge exceeds £2,000, you can elect for the payment to be made from your pension scheme
    • All benefits in excess of your tax free cash entitlement will also be assessed for income tax when they are drawn
  • There is also the ability to “Carry Forward” unused Annual Allowance from previous tax years
  • Exceeding the Annual Allowance in a tax year may not actually lead to a tax charge
  • This is because you can “carry forward” unused Annual Allowance from the previous 3 tax years
  • This may allow your pension benefits to increase more than the Annual Allowance limit for the current tax year without incurring a tax charge. So for example, if last year the increase in your pension benefits was £30k, you are able to carry forward the unused £10k into this year
  • The Lifetime Allowance (LTA) is  £1,073,100
  • If your total pension savings exceed this limit, you may incur a tax charge
  • Exceeding the LTA does not incur an immediate tax charge
  • You are normally assessed against the LTA at the point you receive your pension
  • At this point, you will incur a charge on any benefits that exceed the LTA of:
    • 55% if these benefits are received as a lump sum
    • 25% PLUS your marginal rate of income tax if benefits are received in any other way
  • Defined contribution pensions are valued based on the fund value
  • Defined benefit pensions are valued

Defined benefit pensions are usually valued by multiplying the pension income you receive in the first year by 20.  Any lump sum you receive is then added to this figure

LTA protection

The lifetime allowance reduced from £1.25m on 6 April 2016. Protection may be available to you if you were impacted by this reduction.

  • Available if your pension savings exceeded £1m on 5 April 2016
  • Provides a LTA equal to your pension savings on this date
  • Subject to a maximum LTA of £1.25m
  • There is no deadline for applications
  • Only available to those who ceased all pension contributions prior to 6 April 2016
  • Provides a LTA of £1.25m
  • There is no deadline for applications

It is essential you seek regulated financial advice before making a decision and taking any action on the pension limits.