What are the limits on tax relief?

5 min read

Share

There are limits on the amount you can invest in pension plans and on the maximum value of pension savings that you can build up without being subject to a tax charge.

These limits are known as the annual allowance and the lifetime allowance.

Annual allowance

The contributions you make in a tax year count towards the annual allowance for that tax year.

If you've already taken some of your pension savings, your future pension contribution limit may be restricted to the money purchase annual allowance.

Tax rules depend on your individual circumstances and could change in the future. 

What are the limits on tax relief?

What is tax relief?

The taxman encourages pension saving by giving tax incentives, commonly known as tax relief. Tax relief is restricted to the higher of £3,600 or 100% of your earnings.

Tax relief on pension contributions you make is given in 2 ways:

  • Each time you save into your plan, you’ll receive extra contributions from the taxman which will boost your retirement savings. Everyone who pays tax will receive basic rate tax relief which means a 25% boost on top of your contributions.
  • If you’re a higher rate or additional rate taxpayer you’ll receive a reduction in your tax liability. This is the difference between your basic rate tax relief and the higher or additional rate of income tax you’ll pay.

Tax relief is not added to any contributions made to your pension by your employer.

As a reminder, here are the current income tax rates for England, Wales and Northern Ireland:

  • 20% for basic rate taxpayers
  • 40% for higher rate taxpayers
  • 45% for additional rate taxpayers

And for Scotland:

  • 19% for starter rate taxpayers
  • 20% for basic rate taxpayers
  • 21% for intermediate rate taxpayers
  • 41% for higher rate taxpayers
  • 46% for top rate taxpayers

You can find out more on understanding your pension tax relief here

 

Tax free allowances

There are limits on the amount you can invest in pension plans and on the maximum value of pension savings that you can build up without being subject to a tax charge.

These limits are known as the annual allowance and the lifetime allowance.

Annual allowance

What is it?

The contributions you make in a tax year count towards the annual allowance for that tax year.

If you've already taken some of your pension savings, your future pension contribution limit may be restricted to the money purchase annual allowance.

Tax rules depend on your individual circumstances and could change in the future.

What are the limits?

The government has set a limit on the amount of pension contributions you can make each year before you're taxed. This is called the annual allowance. The annual allowance for the 2020/2021 tax year is £40,000, which means you could contribute £40,000 before a tax charge may apply.

If however, you have taxable income for a tax year greater than £240,000, you'll have your annual allowance for that tax year restricted. This means that for every £2 of income you have over £240,000, your annual allowance is reduced by £1. Your reduced annual allowance is rounded down to the nearest whole pound.

The maximum reduction will be £36,000, so if you have an income of £312,000 or more you'll have an annual allowance of £4,000. If you're caught by the restriction, you may have to reduce the contributions paid by both you and/or your employer or an annual allowance charge will apply.

We recommend you speak to a financial adviser for more information on this legislation.

If you've already taken some of your retirement savings, your future pension contribution limit may be restricted to the money purchase annual allowance.

Money purchase annual allowance

What is it?

The money purchase annual allowance (MPAA) is lower than the annual allowance and it may apply if you choose to flexibly access your retirement savings after 6 April 2015.

The government introduced the MPAA to make sure there's no room to abuse the tax relief that can be claimed on any new pension contributions by those who have taken some or all of their retirement savings.

How does it work?

If you choose to access your retirement savings flexibly, certain payments will trigger the MPAA. This means your annual allowance for contributions into defined contribution arrangements would be reduced from £40,000 to £4,000 a year.

What triggers the MPAA?

  • If you choose to take an income from a flexi-access drawdown plan set up from 6 April 2015.
  • Taking a full or partial cash lump sum withdrawal from your account.
  • Taking an income above the maximum limit from an existing capped drawdown plan.

What won't trigger the MPAA?

  • Taking your 25% tax-free cash sum.
  • Cashing in small pots.Taking an income from a capped income drawdown plan that's within the maximum limits.
  • Additional designation from an existing capped income drawdown plan.
  • Buying a lifetime annuity.

What do I need to do if the MPAA is triggered?

We'll let you know within 31 days of the MPAA being triggered.

You'll have 91 days to inform all pension plans you're contributing to that the MPAA has been triggered. If you join any new pension plans, you'll have a responsibility to let them know.

What about defined benefit pension plans?

If you're a member of a defined benefits pension plan and you've triggered the MPAA, the £40,000 annual allowance still applies to your total contributions/accrual. However, within your total £40,000 annual allowance, the maximum you can contribute to any defined contribution plans will be £4,000 before a tax charge applies.

We recommend you speak to a financial adviser for more information or if you think this applies to you.

Lifetime allowance

There's a limit to the amount you can have built up in all of your pension plans when you start taking your retirement savings. It's set by the government and it's called the lifetime allowance.

The lifetime allowance for 2020/21 is £1,073,100. If you exceed this limit, you may be subject to a lifetime allowance charge.