In previous posts I have explained that I am in the accumulation stage on my retirement planning, looking to build up a retirement pot using the tax advantages of pensions saving.
But because pension saving is tax advantaged the government doesn't want me doing too much of it and there are limits both on the amount I can save in any year and the total lifetime pension pot I can build up. This post looks to outline these limits. Although I work as a tax adviser I specialize in company tax and not pensions, so you need to take this as what it is, some notes on a complicated topic and not a definitive guide.
Limits on annual contributions
Annual Allowance
Every year the government sets out an annual allowance, which is the maximum amount that can be paid into pension pots by an individual in a year without an annual allowance tax charge being triggered. For income tax the year runs from 6th April to 5th April. The annual allowance for 6 April 2014 to 5th April 2015 2015 is £40,000. The annual allowance is tested for the individual and not for the pension pot, so if I had more than one pension pot I would need to amalgamate contributions to all the various pots to see if I broke the £40,000 limit.
There is, however, a ridiculous complication that is the Pensions input period. This was a new one on me but my reading of it is that if you, or your employer, are making contributions to a defined contribution scheme then the pensions input period will just be from 6th April of one year to 5th April of the following year but the situation is more complicated if you are in a defined benefit scheme.
In applying the £40,000 allowance all pension contributions by, and on behalf, of an individual are counted. So that includes employer contributions and any contributions someone else makes on my behalf (fat chance). As I only have defined contribution pension pots the calculation is relatively easy, tot up the contributions made in to my pension and if they are under £40,000 then I shouldn't have to worry Link to HMRC website. However, if you are in a defined benefit scheme then the calculation of contributions can become very complicated.
But even if my contributions are over £40,000 there is still the possibility that the annual allowance charge will not apply, as I can carry forward unused portions of the annual allowance from the three previous years. There is an HMRC example of how this calculation works and also a annual allowance checking tool.
Personal Contributions Cannot Exceed Income
As well as the annual allowance limit, personal pension contributions do not obtain tax relief if they are greater than the higher of
a) £3,600
b) The taxable income of the person making the contribution.
This is a link to the HMRC material on this. But it's important to note that this limit does not apply to employer contributions. This is one reason why I make pension contributions via employer contributions (I have my own company), there are other reasons for using employer rather than employee contributions and I will return to these.
The Lifetime Allowance
As well as the limit on contributions there is a limit on the total amount that can be accumulated in pension pots by any individual. From 6th April 2014 the lifetime limit is £1,250,000 (previously it was £1,500,000.) What this means is that at certain points (generally when I start to take benefits from my pension pot) the value of my pension will be tested against this limit and if I have a pension in excess of £1,250,000 then this excess will be taxed at 55%. As with the annual allowance the test applies to the individual and not the pension pot, so I have to amalgamate all my pension pots (including any defined benefit pots) Personally there is no possibility that I will accumulate more than £1,250,000 in my pensions so I haven't covered this in any detail. But there is some coverage on HMRC's website.
As with other areas the position is fairly simple if you have defined contribution pension schemes, the value of a pot for the purposes of the £1,250,000 lifetime allowance is just the cash value of the pension pots concerned. But it's more complicated where the pension is in a defined benefit scheme. It seems that in this case the pension is valued at the annual pension paid on retirement multiplied by 20 plus any lump sum on retirement. So it's relatively easy for somebody with a good defined benefit pension scheme to hit the £1,250,000 limit.
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