Tax relief on pension contributions

Getting tax relief on pensions means some of your money that would have gone to the government as tax goes into your pension instead. You can put as much as you want into your pension, but 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 taxpayer, in the tax year 2017-18 the standard rule is that you’ll get tax relief on pension contributions of up to 100% of your earnings or a £40,000 annual allowance, whichever is lower.

  • For example, if you earn £20,000 but put £25,000 into your pension pot (perhaps by topping up earnings with some savings), you’ll only get tax relief on £20,000.
  • Similarly, if you earn £60,000 and want to put that amount in your pension scheme in a single year, you’ll normally only get tax relief on £40,000.

Any contributions you make over this limit will be subject to Income Tax at the highest rate you pay.

However, you can carry forward unused allowances from the previous three years, as long as you were a member of a pension scheme during those years.

But there is an exception to this standard rule.

If you have a defined contribution pension, and you start to draw money from it, the annual allowance reduces to £4,000 in some situations (see, The Money Purchase Annual Allowance, below).

From April 2016 the £40,000 annual allowance is also reduced if you have an income of over £150,000, including pension contributions.

For more information, see ‘Tapered annual allowance’ in Pensions and retirement jargon buster.

The Money Purchase Annual Allowance (MPAA)

In the tax year 2017-18, if you start to take money from your defined contribution pension, this can trigger a lower annual allowance known as the Money Purchase Annual Allowance or MPAA.

Last year the MPAA was £10,000 and it was expected that the MPAA would be reduced to £4,000 a year with effect from 6 April 2017, however this proposal was suspended pending the outcome of the general election.

In July 2017 the Government announced its intention to go ahead with the proposals it previously withdrew, including the reduction in the MPAA to £4,000. It also confirmed the reduction would apply from the original date of 6 April 2017.

This change needs to be implemented through a new Finance Bill, expected late summer, early autumn 2017. However, in the meantime we would suggest that you do not exceed the £4,000 limit if you are affected by the MPAA.

Alternatively, consult with a regulated financial adviser for advice on how to proceed.

For the latest update go to moneyadviceservice.org.uk/change-to-MPAA.

Whether the MPAA applies depends on how you access your pension pot and there are some complicated rules around this.

As a basic guide though, the main situations when you’ll trigger the MPAA are:

  • If you take your entire pension pot as a lump sum or start to take ad-hoc lump sums from your pension pot
  • If you put your pension pot money into a flexi-access drawdown scheme and start to take income
  • If you buy an investment-linked or flexible annuity where your income could go down
  • If you have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap

And you won’t normally trigger it if you take:

  • A tax-free cash lump sum and buy a lifetime annuity that provides a guaranteed income for life that either stays level or increases A tax-free cash lump sum and put your pension pot into a flexi-access drawdown scheme but don’t take any income from it.

You cash in small pension pots valued at less than £10,000. You can’t carry over any unused MPAA to another tax year.

The MPAA 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 £2,880 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 lifetime allowance puts a top limit on the value of pension benefits that you can receive without having to pay a tax charge.

The lifetime allowance is £1 million for the tax year 2017-18.

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 is being gradually phased in requiring employers to automatically enrol all eligible workers into a workplace pension.

It requires a minimum total contribution, made up of the employer’s contribution, the worker’s contribution and the tax relief.

Find out more in our guide below.

Automatic enrolment into a workplace pension scheme.

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