In April 2023, the pension Annual Allowance increased from £40,000 to £60,000. A recent Professional Adviser report, though, suggests that only around a third of high net worth individuals maxed out the new allowance last year.
Your pension is incredibly tax-efficient but it’s important to make the most of these tax efficiencies if you can afford to.
Keep reading for a closer look at what the Annual Allowance is, what it does, and how to make the most of it as you save for your dream retirement.
Making full use of the Annual Allowance can help you to save for your retirement tax-efficiently but different allowances can apply
In April 2023, the Annual Allowance rose by 50%. For the 2024/25 tax year, it stands at £60,000 (or 100% of your earnings, if lower).
It’s worth noting, though, that a lower allowance might apply if your income exceeds certain thresholds or you have already flexibly accessed your pension.
Annual Allowance
Your Annual Allowance is the maximum amount you can contribute to your pension in a single tax year without facing an additional tax charge.
The Annual Allowance applies to your private pensions and includes all contributions into defined contribution (DC) schemes, whether from you or anyone else, like your employer. It also includes an increase in any defined benefit (DB) schemes you hold.
If you exceed the £60,000 threshold during the tax year, there’ll usually be tax to pay, either by you or your provider. You do, though, have the option to carry forward unused allowance. You can carry forward unused Annual Allowance from the three previous tax years.
Be sure to check your previous record if you think you can afford to contribute up to, or beyond, the current allowance.
Money Purchase Annual Allowance
When you take income from your DC pension pot using certain “flexible” options, you might trigger the Money Purchase Annual Allowance (MPAA).
This reduces your Annual Allowance from £60,000 to just £10,000 (for 2024/25). While this is a large drop, it’s worth noting that the MPAA too was increased in April 2003, up from just £4,000.
There are many reasons – including opting for phased retirement – that might mean you take benefits from one pension while continuing to contribute to another. Doing so may well trigger the MPAA, but the important thing is to be aware that the lower allowance exists and to ensure it’s factored into your plans.
Tapered Annual Allowance
If you’re a high earner, you might find that your allowance is reduced through the Tapered Annual Allowance.
While these calculations can be complicated, the taper effectively reduces your Annual Allowance by £1 for every £2 of “adjusted” income above £260,000.
For 2024/25, the taper continues to a maximum reduction of £50,000. This means that those with an adjusted income of £360,000 or more will have a Tapered Annual Allowance of just £10,000.
Your allowance won’t be reduced if your “threshold” income is £200,000 or less, no matter what your adjusted income is.
Maximise your allowance if you can afford to, whichever one applies to you
As we have already seen, the Annual Allowance for 2024/25 is £60,000 (or 100% of your earnings, if lower). This is the amount you can save in your pension pots before a tax liability occurs.
Maxing out your allowance (without exceeding it) allows you to claim tax relief on these contributions.
You benefit from automatic tax relief at the basic rate of Income Tax (20%), meaning that a £100 increase to your pension pot costs you just £80. But as a higher or additional-rate taxpayer, you can claim an additional 20% and 25% respectively, via your self-assessment tax return.
This increases your relief to 40% or 45%, meaning your £100 pension top-up costs you just £60 as a higher-rate taxpayer and just £55 if you pay tax at the additional rate.
In 2023, PensionsAge found that between 2016/17 and 2020/21, UK employees paying the additional and higher rate of Income Tax failed to claim around £1.3 billion in tax relief.
The report estimates that higher-rate taxpayers failed to claim £245 million on average, each year. For additional-rate taxpayers, this figure was around £18 million. During 2021/22, this amounted to £425 each for higher-rate taxpayers, and around £527 for those on the additional rate.
Understanding the allowance that applies to you and then making full use of it will allow you to benefit from tax relief on your contributions, but you must claim the extra relief due.
Doing so will give you the best chance of building a pension pot large enough to sustain your desired lifestyle throughout your retirement.
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Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
