Tax relief and pensions

Annual and lifetime limits

Tax relief 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 2016/17 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, the annual allowance reduces to £10,000 in some situations.

From 6 April 2016, the £40,000 annual allowance is now reduced if you have an income of over £150,000, including pension contributions.

The Money Purchase Annual Allowance (MPAA)

In the tax year 2016/17, if you start to take money from your defined contribution pension, this can trigger a lower annual allowance of £10,000 (the MPAA). That means you’ll only receive tax relief on pension contributions of up to 100% of your earnings or £10,000, whichever is the lower.

Whether the lower £10,000 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 typically:

• 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

You will not trigger it 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 £10,000 only applies to contributions to defined contribution pensions. So, if you also have a defined benefit pension (this pays a retirement income based on your final salary and how long you have worked for your employer and includes final salary and career average pension schemes), you can still receive tax relief on up to £40,000 of contributions a year.

For example, if you earn £20,000 a year and you contribute £8,000 to your defined contribution pension for the tax year 2016/17, you’ll receive tax relief on these contributions, plus you can still receive tax relief on up to £12,000 of contributions to your defined benefit pension.

If you earn £50,000 a year and you contribute £12,000 to your defined contribution pension for the tax year 2016/17, you’ll receive tax relief on just £10,000 (and the other £2,000 will be subject to Income Tax). In addition, you can contribute up to £30,000 to your defined benefit pension and claim tax relief on this.

Tax relief if you’re a non-taxpayer

If you are not earning enough to pay Income Tax, you can still receive tax relief on pension contributions up to a maximum of £3,600 a year or 100% of earnings, whichever is greater, subject to your annual allowance. For example, if you have relevant income below £3,600, the maximum you can pay in is £2,880, and the Government will top up your contribution to make it £3,600.

How much can you build up in your pension?

A lifetime allowance puts a limit on the value of pension benefits that you can receive without having to pay a tax charge. The lifetime allowance is £1m for the tax year 2016/17. 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 been 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.

Will your pension income last for the rest of your life?

Following the biggest reforms to pensions in recent times, whilst the ability to unlock pension pots is attractive you also need to understand the tax implications of doing this and accept the risk of ensuring that the funds built up are managed effectively to ensure that they last for life. To discuss your situation, please contact Reeves Financial on 01403 333145 or email areeves@reevesfinancial.co.uk – we look forward to hearing from you.

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