The annual allowance is the maximum amount of money you can save into your pension each year while still enjoying tax relief. This is the 25% top-up the government adds to any pension contributions. For example, if you put in £10,000, the government tops it up with £2,500. Your £10,000 has magically become £12,500.
Following the 2023 budget, the annual allowance currently stands at £60,000. If you earn less than £60K per year, the most you can put into your private or workplace pension (or pensions, if you have more than one) is your total gross salary.
If you go over this annual allowance, you will be charged. And if you are earning more than £260,000, things get more complicated still. So let’s see if we can clarify matters.
If you've been a little overenthusiastic and saved more than your annual allowance into your pension, the amount that exceeds the limit might be taxed. This is often referred to as an 'annual allowance charge'. It's a way of balancing the scales because you've received tax relief on more than the annual allowance.
There are a few scenarios where this might happen.
However, the good news is that, even if you have exceeded your annual allowance and are charged for it, you can still claim the tax relief on your contributions via a self assessment tax return.
Here's where it gets a tad more complex. For high earners, the government has introduced something called 'tapering'. If your 'adjusted income' (basically all your income plus any pension contributions) goes above £260,000, the annual allowance starts to reduce (or 'taper' down).
For every £2 of income above £260,000, your annual allowance is reduced by £1 but the lowest it can go due to this tapering is £10,000. However, depending how much you have contributed to your pension in previous years, there may be something you can do about it.
If you’re a high earner with a reduced annual allowance, there's a neat little trick called 'carry forward' that might help you out. This lets you use any unused annual allowances from the previous three tax years.
For example, if you’ve only used £20,000 of your allowance two years ago, you could potentially carry forward the unused £40,000 to this year, giving you a larger allowance for the current year (assuming that you weren’t a high earner subject to tapering in previous years).
However, to use 'carry forward', you must have been a member of a pension scheme (even if you didn’t make contributions) during the year from which you wish to carry forward.
While pensions and allowances can seem a bit like a jigsaw puzzle, understanding the basics like the annual allowance and its nuances can make planning for the future a smoother process.
For high earners, it's particularly crucial to be aware of tapering and to keep the 'carry forward' trick up your sleeve. Remember, it's always a good idea to consult with a financial advisor to make the most out of your pension planning. Happy saving!