Pension annual allowance pitfalls – how to navigate them

The number of people who have breached their annual allowance has spiralled from 5,460 in the 2015/16 tax year to 42,350 just four tax years later. That’s a whopping 675% increase over this time and seems to indicate an overly complex system that’s catching people unaware.

The annual allowance is the maximum amount that can be contributed across all your pensions each tax year without incurring a tax charge.

The regime’s evolved rapidly in recent years. As early as 2010/11, the annual allowance was £255,000, but it’s since been slashed.

The current annual allowance for most people is £40,000. This includes any contributions your employer makes to your pension as well as your own. But there’s more to it than that.

As well as the annual allowance, how much you can pay into a pension is also limited by how much you earn. If you’re a non-earner, or earn less than £3,600 a year, you can contribute up to £3,600.

Find out more about pension contributions

If you have already accessed your pension or are a higher earner, your annual allowance could also have been cut to as low as £4,000 a year. These more recent changes might well be behind the surge in people breaching their annual allowance.

This article isn’t personal advice. If you’re not sure what’s right for you seek advice.

Pension and tax rules are subject to change and impacts depend on personal circumstances. You can’t usually access money in a pension until at least age 55 (rising to 57 in 2028).

What’s the tapered annual allowance?

This allowance limits the amount that can be contributed to the pensions of higher earners and still benefit from tax relief.

If you have a threshold income of above £200,000 and an adjusted income of more than £240,000, you will see your annual allowance gradually reduce. It will reduce by £1 for every £2 of adjusted income over the £240,000 limit. This means if your adjusted income was £280,000, you’d have an annual allowance of £20,000. If your adjusted income was £312,000 or more, your annual allowance would be £4,000.

Broadly speaking, threshold income is your total taxable income plus any salary/bonus sacrificed for pension contributions, minus any personal pension contributions you make. Adjusted income is, broadly, your total taxable income plus any employer pension contributions.

More on annual allowances

It’s a complex system and needs to be carefully managed as any fluctuation in your income can affect your annual allowance in any given year. Even a small shift in pension contributions or salary, could mean you get hit with a lower annual allowance which you might accidentally breach.

What about the Money Purchase Annual Allowance (MPAA)?

The MPAA was introduced in 2015. Under this rule, anyone who has flexibly accessed a money purchase (defined contribution) pension can only contribute up to £4,000 a year to money purchase pensions and benefit from tax relief.

The MPAA can catch out anyone who’s flexibly accessed their pension. It means annual allowance breaches aren’t something just high earners need to be wary of.

It could prove especially problematic for those who were forced to dip into their pensions to supplement their income during the pandemic. The MPAA means they might now be restricted to contributing up to £4,000 per year, which could hamper their attempts to rebuild their retirement income. It could also be an issue during the ongoing cost-of-living crisis as people dip into savings to meet their rising costs.

How to boost your contribution

There are circumstances where you can contribute above your annual allowance, without being penalised.

One way is by using the carry forward rule. Using carry forward means you can use any unused allowances from the previous three tax years to boost your contribution. This means in some cases, up to £160,000 could be contributed, across both your own and your employer contributions, to your pension, without incurring an annual allowance tax charge.

Use our carry forward calculator to get an idea of how much you might be able to pay in.

If your focus is on family financial planning, you can also contribute to your spouse or partner’s pension if they have enough allowance left. You can contribute up to £2,880 (topped up by up to £720 in basic-rate tax relief) a year to the pension of a non-earning spouse or partner.

If they’re earning, you can contribute up to £40,000, or their earnings for that year if lower, in the same way as you would your own pension – their own contributions, as well as tapered and money purchase annual allowances, permitting.

You can also contribute to a child’s pension. You can contribute up to £2,880 a year to a child’s pension, which will be topped up with basic-rate tax relief of up to £720, making a total contribution of up to £3,600. It’s a great way to get your child’s pension planning off to a flying start.

Pensions can be a great tax-efficient way to plan for your retirement. But there are hidden pitfalls you should be aware of. Navigating them successfully means you’re far less likely to be hit with a nasty tax charge.

Learn more about contributing to your pension