Understanding tax relief and pensions – annual and lifetime limits
When it comes to managing money, one of the things some people find most difficult to understand is the tax relief they receive on payments into their pension. For most taxpayers, tax relief means some of your money that would have gone to the Government as tax goes into your pension instead but even non-taxpayers receive basic rate tax relief. Whilst you can put as much as you want into your pension, 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 earner/resident, in the tax year 2018/19 the standard rule is that you’ll receive tax relief on your own pension contributions of up to 100% of your earnings or £3,600 if more. There is also a £40,000 annual allowance which applies to total contributions from yourself and your employer and if exceeded means a tax charge will apply on the excess contributions. Any excess contributions (whether made by you or your employer) will be added on top of your other income and taxed accordingly, although in some cases it is possible for the tax charge to be paid out of your pension benefits. However, you can carry forward unused annual allowances from the previous three tax years, as long as you were a member of a pension scheme during those years.
There are some exceptions to the standard annual allowance figure. If you have a defined contribution/money purchase pension and you start to draw money from it flexibly, the annual allowance is reduced to £4,000 in respect of future money purchase contributions (although up to the full £40,000 is available in relation to defined benefit scheme funding if you are also a member of a defined benefit scheme).
The standard annual allowance is also reduced by £1 for every £2 of adjusted income above £150,000 if your adjusted income exceeds £150,000 and your threshold income exceeds £110,000. The annual allowance can’t be reduced to below £10,000 though. Carry forward remains available but in any year where the taper applies only the balance of the tapered amount is available to carry forward.
The money purchase annual allowance (MPAA)
In the tax year 2018/19, if you start to take money from your defined contribution pension flexibly, this will trigger a lower annual allowance of £4,000 in respect of future money purchase pension contributions. This is known as the ‘Money Purchase Annual Allowance’ (MPAA). That means you’ll suffer a tax charge if your total pension contributions (employer and employee combined) exceed £4,000. Whether the lower £4,000 annual allowance applies depends on how you access your pension pot, and there are some complicated rules around this.
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
The MPAA will not be triggered 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 £4,000 only applies to contributions to defined contribution pensions and not defined benefit pension schemes.
Tax relief if you’re a non-taxpayer
If you’re not earning enough to pay Income Tax, you’ll still qualify to have tax relief added to your contributions up to a certain amount.
The maximum you can pay is £3,600 gross (£2,880 net of basic rate tax relief) a year or 100% of your earnings – subject to your annual allowance.
Tax relief is added to your contribution, so if you pay £2,880, a total of £3,600 a year will be paid into your pension scheme, even if you earn less than this.
How much can you build up in your pension?
A pension lifetime allowance puts a top limit on the value of pension benefits that you can receive without having to pay a tax charge.
The pension lifetime allowance is £1,030,000 for the tax year 2018/19. 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 has being gradually phased in requiring employers to automatically enrol all eligible workers into a workplace pension. It requires a minimum total contribution and a minimum employer contribution and the employee must make up any shortfall between the two. In most cases the total contributions are made up of the employer’s contribution, the worker’s contribution and the tax relief.
The Financial Conduct Authority does not regulate tax advice.
Please contact Matthew Bromley, Chartered Financial Planner at Cowgills Wealth Management for further advice or to discuss your situation.
This article is for general guidance only. It provides an outline, and may not include points which are important to your situation. You should not depend on this blog without taking advice based on the full facts of your case. The information given was correct at the time of publication.
The information was correct at time of publishing but may now be out of date.