What is the pension annual allowance and how does it work?

There is a limit to how much you can contribute into your private pensions each tax year, and this limit is called the annual allowance.

Read on to find out what this limit is, how it may change and how it affects the different types of pension schemes.

What is the annual allowance?

The pension annual allowance is the most you can pay into pensions in a single tax year and still receive tax relief. The current annual allowance is £60,000.

It’s important to note that the allowance covers all your private pensions combined – so if you have a personal pension and a workplace pension, you would have to split the allowance between them (e.g., £30,000 into each).

What happens if I exceed my annual allowance?

There are two main consequences of going over your annual allowance.

The first is that you won’t receive tax relief on the excess amount.

The second, more serious issue is that you will face an addition to your tax bill for that year (called the annual allowance charge).

The excess contributions are added to your gross income for that year, and your income tax bill is recalculated accordingly based on this higher figure.

If the charge is over £2,000 then you can ask for it to be deducted from your pension instead.

What counts towards the annual allowance?

All of your contributions into your pension pots, plus any that your employer makes, counts towards your annual allowance.

Tax relief also counts, so the amount you can pay in is actually less than £60,000 of your net salary (because tax relief at 20% effectively increases each contribution by 25%).

This is why it’s important to keep careful track of your contributions if you think you might be near the limit.

How do I calculate my annual allowance?

HMRC offers a series of calculators on its website to help you work out whether you have exceeded the annual allowance.

Most people affected by this issue will want to use this calculator, but others are available for those whose circumstances are different.

Can I carry forward my pension annual allowance?

You can carry forward any unused annual allowance from the past three tax years.

For the 2024/25 tax year, the annual pension allowance is £60,000. This allowance increased from £40,000 in the 2023/24 tax year.

If you contributed less than the annual allowance in these years, you can carry forward the unused amount.

So, for example, if you contributed £30,000 each year from 2021/22 to 2023/24, you would have unused allowances of £10,000 for each of the 2021/22 and 2022/23 tax years, and £30,000 for 2023/24. This totals £50,000 of unused allowance.

For the 2024/25 tax year, you can add this £50,000 to the £60,000 allowance for that year, allowing you to contribute up to £110,000 in total without facing an annual allowance charge, provided your income can support such a contribution. Note, however, that you can’t do this if you are already on the money purchase annual allowance (MPAA).

How does the annual allowance work for final salary pensions?

Final salary pensions (also known as defined benefit pensions), work in a different way from pension pots.

They provide a guaranteed income for life, so there is no definite pot size on which to base the sums. This makes it more complex to calculate how close you are to the annual allowance.

Usually, you will have to ask your pension scheme or a financial adviser to work this out for you.

Broadly, however, the allowance is worked out like this.

First, the total value of your pension is calculated, based on how much income it could provide over a typical retirement.

This calculation is done at the start of the year, and then again at the end of the year. The difference in these figures is considered to be the amount ‘contributed’ to the pension.

If this figure exceeds the annual allowance, then there will be the annual allowance charge to pay.

What is the annual allowance taper and who is affected?

People with a very high income have a reduced annual allowance. Up to an adjusted income of £260,000, you receive the full annual allowance.

However, for each £2 of adjusted income over this figure, your annual allowance is reduced by £1.

This continues until you reach the minimum annual allowance of £10,000.

Adjusted income is your total income plus any pension contributions you make in that year that aren’t from your income (so you can’t get around this by using salary sacrifice, for example).

You can find out more about the pension tapered annual allowance here.

When might my pension annual allowance be lower?

Your annual allowance can be reduced in two ways: either if you earn over £260,000 (see above) or if you start to access your pension pot(s) in a way that qualifies as a ‘trigger event’.

A trigger event can occur in many scenarios, including setting up a drawdown scheme and starting to take an income (but not if you buy certain types of annuities).

This reduces your annual allowance to the MPAA, which is currently £10,000.

Find out what is a good amount to pay into your pension, and talk to a financial adviser if you’re concerned about exceeding your pension annual allowance.

This can be a particular risk for those who have final salary pensions, such as workers in the NHS.

Get expert financial advice

The pension annual allowance is crucial for maximising your retirement savings.

By staying informed about the allowance limits, how to calculate contributions, and the implications of exceeding the allowance, you can make well-informed decisions about your pension contributions.

Whether you're making use of carry-forward options or navigating the complexities of final salary pensions and the tapered annual allowance, staying on top of these will help you make the most of your pension benefits and ensure a secure financial future.

Let Unbiased match you with a financial adviser for expert financial advice on managing your pension contributions and staying within your annual allowance.