A pension is one of the most tax efficient ways you can save for your retirement. You can contribute up to 100% of relevant UK earnings each tax year, up to the Annual Allowance, and receive tax relief. The Annual Allowance is the limit on the amount you can save into your pension in a tax year and benefit from tax relief. The standard Annual Allowance for the 2022/23 tax year is £40,000.
The Annual Allowance applies to all of your private pensions and includes your personal contributions, your employers contributions and any third party payments made into your pension(s) in a tax year. It also includes the basic rate tax relief which is added to your pension.
If your relevant UK earnings are £20,000 in a tax year, and assuming you don't receive any employer or third party contributions into any pension, you could make a personal contribution of £16,000 into your pension. You will receive £4,000 basic rate tax relief, which is added to your pension savings, which gives a gross contribution of £20,000. Investment income, dividends and pension income don't count as relevant UK earnings.
For a Defined Benefit ('Final Salary' or 'Career Average') Scheme, the Annual Allowance is the increase in the Scheme in a tax year. It can be complicated to calculate the Annual Allowance for Defined Benefit Schemes and professional advice is usually required.
Any excess contributions over the Annual Allowance will be taxed at your marginal rate of income tax. You can 'carry forward' unused Annual Allowance from the 3 previous tax years. The contribution paid into your pension will use this year's Annual Allowance first and then any unused Annual Allowance from the 3 previous tax years.
The Annual Allowance may be lower if you have flexibly accessed your pension and taken taxable income, or if you are a high earner and subject to the tapered Annual Allowance. The tapered Annual Allowance applies if your 'adjusted income' is over £240,000 and your 'threshold income' is over £200,000. The threshold income and adjusted income limits are different for earlier tax years.
If you are not working, you can pay up to £3,600 gross (£2,880 net) into your pension each tax year. So you pay £2,880 into your pension and receive basic rate tax relief of £720, which is added to your pension. You can pay into a pension and receive tax relief until age 75.
Please note that this information is based on my current understanding of the relevant legislation and regulations. This is guidance only and not personal advice and professional advice should be sought before making any investment decisions.
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