The great news on saving for your retirement with a pension is that some of the money that would normally have gone to the government goes back into your savings in the form of tax relief. This can be a significant amount when it’s saved over many years.

You can put as much money as you want into your pension, but there are limits on the amount of pension savings that can benefit from tax relief each year and over the course of your lifetime. It’s worth being aware of these limits because, if you exceed them, you may have to pay tax on the excess. Here are the latest allowances for the tax year 6 April 2021 – 5 April 2022.

Annual Allowance

The Annual Allowance is the limit on the amount of pension savings that can benefit from tax relief in a single tax year. This limit is equal to 100% of your annual earnings, or £40,000 in each tax year, whichever is lower.

If you have a Defined Benefit pension arrangement (also known as ‘final salary’ or ‘career average’), then the value of the benefits you build up during the tax year is measured against the Annual Allowance. If you are a member of a Defined Contribution arrangement (also known as ‘money purchase’ and including the BRASS, AVC Extra and the IWDC Section arrangements), then it is the total of any contributions paid in during the year that is measured against the Annual Allowance. This includes contributions paid by you and your employer. The Annual Allowance applies to all pension schemes that you belong to and is not a “per scheme” limit.

Tapered Annual Allowance

If you’re a high earner, you may be subject to a lower Annual Allowance, known as the Tapered Annual Allowance. This lower limit affects you if your ‘threshold income’ (i.e. your annual income from all sources before tax) is over £200,000 and your ‘adjusted income’ (i.e. your annual income before tax, plus the level of your pension savings) is over £240,000. For every £2 of adjusted income over £240,000, you lose £1 of Annual Allowance, up to a maximum reduction of £36,000. This means that anyone with an adjusted income of £312,000 or more has a Tapered Annual Allowance of £4,000.

Money Purchase Annual Allowance

If you’ve started to draw money from any Defined Contribution arrangement of which you’re a member, then (regardless of your income) future savings that you make in to a Defined Contribution arrangement may be subject to a lower annual allowance of £4,000. This is known as the Money Purchase Annual Allowance.

You would need to check the rules to see if the Money Purchase Annual Allowance applies to you (see ‘Further information’ below) but the main situations when you might trigger the Money Purchase Annual Allowance are if you:

• take all of your Defined Contribution savings as a lump sum
• start to take ad-hoc lump sums from your Defined Contribution savings
• put your Defined Contribution savings into an income drawdown fund and start to take an income
• were in a flexible drawdown arrangement before 6 April 2015.

HMRC found that around 260,000 pension savers triggered the Money Purchase Annual Allowance in 2020. These individuals will now have to pay tax on any Defined Contribution savings above £4,000 in a tax year.

Lifetime Allowance

The Lifetime Allowance is the limit on the total amount of pension savings that can benefit from tax relief. The Lifetime Allowance affects those with the largest pension savings and 95% of pension scheme members approaching retirement are unaffected by it. In the Spring Budget 2021, the Chancellor announced that the Lifetime Allowance will stay at its current level of £1,073,100 until 2026. This limit had been expected to increase every tax year in line with inflation.

Further information

More detailed information on the Annual Allowance, Money Purchase Annual Allowance and Lifetime Allowance can be found here or under the resources menu on this BTP website.

You may wish to take independent financial advice regarding your pension decisions.  If so visit unbiased.co.uk for a list of trusted local advisers.