For most people, pensions are the best way to save for retirement, thanks to generous tax relief and tax-free growth over the long term.
However, there’s a limit to how much you can save into pensions. There is a cap on how much you can contribute to a pension in a single year (your annual allowance), and also a limit to how much you can draw out of pensions in your lifetime (your lifetime allowance). Although both limits are generous, higher earners and some self-employed people may run the risk of exceeding either or both.
Your annual allowance
The most you can pay into pensions in a single tax year, and still receive tax relief, is either £40,000 or 100 per cent of your qualifying earnings (whichever is greater). It may sound odd to pay your entire earnings into a pension, but it can happen (for instance if you have savings). It is also a common pitfall for company directors, who may take most of their income as dividends, with only a small salary. Dividends don't count as 'relevant UK earnings' for this purpose, so the maximum annual pension contribution would be equal to the (small) salary.
If you exceed this allowance, you won’t receive tax relief on the excess, and you will also have to pay an annual allowance charge. However, you can carry forward (below) any unused annual allowance from the past three tax years.
If you have started to access you pension pots, but want to keep paying money into them, then be aware that your annual allowance might shrink to £4,000 for all defined contribution schemes you're in, and £36,000 for all defined benefit schemes. This is called the Money Purchase Annual Allowance and is a complex area that you should take financial advice on.
Carry Forward
Carry forward allows you to make use of any annual allowance that you may not have used during the three previous tax years, provided that you were a member of a registered pension scheme.
You can use carry forward if you’re an active member currently building up pension benefits, a deferred member with paid-up pension benefits, a pensioner member in receipt of pension benefits from your pension scheme or a pension credit member where you have a share of your ex-partner’s pension. If an annuity policy is in the name of an individual and, when the contract was made, the annuity policy was not of such a type to be from a registered pension scheme, then the individual cannot be a pensioner member and therefore cannot use this to qualify for carry forward.
Carry forward may be particularly useful if you are self-employed and your earnings change significantly each year or if you’re looking to make large pension contributions.
To use carry forward, you must make the maximum allowable contribution in the current tax year (£40,000 in 2019/20) and can then use unused annual allowances from the three previous tax years, starting with the tax year three years ago.
It is therefore possible that during the 2019-20 tax year you might have £160,000 of payment that you can make tax efficiently towards a pension scheme.
Your lifetime allowance
You can draw a maximum £1 million from pensions in your lifetime without triggering an extra tax charge. Note that the allowance is defined as the amount you draw out – but in practice it helps to think of it as a limit on how big you can let your pension pots grow.
If you tend to pay a lot into pension schemes, it is possible to exceed the allowance without meaning to. Your pots may grow by more than expected, or you may be automatically enrolled in a new pension scheme when starting a new job. It is even possible to exceed the allowance when you die – some death-in-service benefits are set up to pay directly into the pension scheme itself.
If you exceed the lifetime allowance, any excess will be taxed at 25 per cent if taken as income, or at a hefty 55 per cent if taken as a lump sum.
As you can see there are many different things to consider and it is crucial that you get Independent Advice.
As always, why not contact us for a chat on how we might be able to help.