Work is also ongoing to improve value for money and transparency of investments within pension funds – in particular, by focusing on encouraging investment in UK securities.

The current position regarding the tax consequences of making pension contributions is as follows.

Tax relief on pension contributions

There are three ways in which tax relief on pensions is restricted:

1. The annual earnings limit

The absolute maximum level of pension contributions that you can make with tax relief is restricted to your ‘relevant UK earnings’ taxable in the year, or £3,600 if you have no such earnings or they are below that level.

Broadly speaking, the relevant UK earnings include your employment and self-employment income, any furnished holiday letting (FHL), and patent income. With the abolition of the FHL scheme on 6 April 2025, however, that income may no longer be classed as relevant earnings. We await the legislation to confirm details. 

Relevant earnings do not include investment income. Employer contributions to your pension are not, however, restricted to earnings.

2. The annual allowance

If your ‘total pension inputs’ exceed the annual allowance of £60,000, there is a tax charge on the excess at your marginal income tax rate. Your total pension inputs include:

• personal and employer contributions to defined contributions or ‘money purchase’ schemes, and
• growth in defined benefit or ‘final salary’ schemes.

3. The lifetime allowance

You can usually take up to 25% of your pension value as a tax-free lump sum. Prior to 6 April 2023, however, there was a tax charge if your total pension pot exceeded the lifetime allowance (LTA), which was £1,073,100 in recent years.

This charge was abolished for 2023/24, however, and the LTA is to be removed from 6 April 2024. It is being replaced with a ‘lump sum allowance’ of £268,275 and a ‘lump sum and death benefit allowance’ of £1,073,100, which limits the amounts of tax-free benefits that can be paid.

These allowances might be higher if you have enhanced or fixed protection, which was available when the LTA was reduced in previous years.   

A new ‘overseas transfer allowance’, also £1,073,100, is being introduced for transfers to qualifying overseas pension schemes.

A change of Government could reverse these changes though.

THE ANNUAL ALLOWANCE

The annual pension allowance changes in the following circumstances:

Carry forward

If you have not fully used your annual allowance in a year, any unused amount can be carried forward for up to three years.

Money-purchase

If you have already started drawing your pension, the annual allowance is reduced to £10,000.

Tapering

If your ‘adjusted income’ (that’s your total income before pension contributions plus employer contributions) is more than £260,000 for the tax year, the annual allowance is reduced by £1 for every £2 that your adjusted income exceeds £260,000.

It then tapers down to a minimum of £10,000, which happens when your income is £360,000.

You will not suffer the reduction if your ‘threshold income’ (total income excluding pension contributions) is no more than £200,000.

A very simple example

Say you have an adjusted income of £310,000 for the 2024/25 tax year. This exceeds the adjusted income limit by £50,000.

Your annual allowance would be reduced by half of this (so by £25,000), leaving you with a tapered annual allowance of £35,000.

Under the tapering rules, this is the standard annual allowance of £60,000 less the £25,000 reduction.

Making pension contributions in excess of the allowance

There is no limit to how much you can contribute to a pension scheme, but if…

• you make contributions to a money-purchase scheme or
• your defined benefit (‘final salary’) pension increases

… in excess of the allowance, you should include the excess amount on your self-assessment tax return. You will have an income tax charge at your marginal rate.

If the tax charge is more than £2,000, you can elect for your pension scheme to pay the charge on your behalf. This may, however, result in a reduction to your pension at retirement.

Qualifying for tax relief on pension contributions

To get tax relief on pension contributions, you must be a ‘relevant UK individual’, which includes someone who:

• has relevant UK earnings taxable in the UK
• is a UK resident at some time in the tax year
• is resident in the UK at some time in the previous five tax years and when they joined the pension scheme
• who (or whose spouse/civil partner) has earnings from Crown employment overseas subject to UK tax.

The pension scheme must also be registered in the UK.

Age implications

Tax relief is available on pension contributions made from birth. So, parents or grandparents could make contributions on behalf of a child, up to £3,600 gross (£2,880 net) even if the child has no earnings.

The child receives the tax relief, but there could also be inheritance tax savings – for example, if the annual exemption is used or if they become ‘normal expenditure out of income’ for the parent or grandparent.

There is no tax relief for personal pension contributions made after you reach the age of 75. Relief is still available, however, (for the employer) for employer contributions.

High income earners

60% tax relief (67.5% from 2024/25 if Scottish tax rates apply) is available if your income is between £100,000 and £125,140. This is because the personal allowance is then tapered, so you are paying 40% tax on the lost allowance as well as 40% tax on the income (45% in Scotland).

Be aware that the personal allowance disappears altogether when your income reaches £125,140. Pension contributions reduce your adjusted income, so personal allowances would be reinstated if your contributions can reduce your income to £100,000 or less.

If a salary sacrifice arrangement is in place, the tax relief will be even greater.

Recent changes to be alert to

Although the LTA is now abolished, the maximum tax-free lump sum is frozen at 25% of £1,073,100 = £268,275.

From 6 April 2023, the tax rate for lump sums paid exceeding the tax-free allowances changed from 55% to the individual’s marginal income tax rate (20%, 40% or 45%—different rates apply to Scottish taxpayers).

Taking a lump sum could push income into a higher rate than usual, and tax may be deducted at an emergency rate, but repayment can be claimed before the end of the tax year.

CAN WE HELP?

If you need further guidance about any of the information outlined here, please speak with your usual Shipleys contact or one of our team of specialists shown on this page.

Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary. If you would like advice or further information, please speak to your usual Shipleys contact.

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