Most pension contributions are tax-free up to certain limits. This includes personal and stakeholder pensions, workplace pensions and overseas pension schemes and qualifies for UK tax relief. However, you need to know to keep some points in mind regarding annual allowance and lifetime allowance as you need to pay tax on your private pension contributions.
When do you pay tax on your pension contributions?
There are limits to your tax-free contributions and you generally pay tax in the event of your savings in the pension pot going above:
- £40,000 a year
- 100% of your earnings in a year
- £1,073,100 in your lifetime (known as lifetime allowance)
Additionally, you also pay tax on contributions if your pension provider either does not invest in your pension pot according to HMRC’s rules or is not registered for tax relief with HMRC.
What is an annual allowance?
Your annual allowance is the most that can be saved in your pension pots in a tax year before you are required to pay tax. And you will only be required to pay tax if you go above the annual allowance limit i.e. £40,000.
What does the annual allowance include?
The annual allowance applies to all your private pensions. In case you have more than one pension, it includes:
- The total amount paid into a defined contribution plan in a tax year by you or someone on your behalf
- Any increase in a defined benefit scheme
What happens if you use all your annual allowance for the current tax year?
You can carry over any annual allowance you did not use from the previous three tax years.
Does your annual allowance get lower than £40,000?
Yes, your annual allowance gets lower than £40,000 if you have either flexibly accessed your pension pot or have a high income
What does flexibly accessing your pension pot mean?
Flexibly accessing your pension pot means that you have either taken out:
- Cash from a pension point; or
- Cash or a short-term annuity from a flexi-case drawdown fund
What happens if you have a high income?
You will have reduced (tapered) annual allowance in the current tax year if both:
- Your ‘threshold income’ is over £200,000
- Your ‘adjusted income is over £240,000
Please note that the threshold income and adjusted income limits are different for earlier tax years.
What if you exceed the annual allowance limit?
You will get a statement from your pension provider if you exceed the annual allowance limit. You can ask each pension provider for statements if you are in more than one pension scheme. To check if you have an annual allowance tax charge on your pension savings, click here. It is important to note, however, that HMRC does not tax anyone for going over their annual allowance in a tax year if they either died or retired and took all their pension pots due to serious health.
What is the limit of lifetime allowance?
Currently, the limit of lifetime allowance is £1,073,100 and you usually pay tax if your pension pots are worth more than this allowance. Why and when does your pension provider ask for information about other pension schemes you are in? Pension providers ask for information about other pension schemes you are in to determine whether you have exceeded your lifetime allowance limit when:
- Taking out money from a pension pot
- Transferring your pension overseas
- Turning 75
What happens when you exceed your lifetime allowance limit?
You will get a statement from your pension provider informing you about your tax liability if you exceed your lifetime allowance. Also, the pension provider will deduct the tax before you start getting your pension. Additionally, HMRC will bill the person who inherits your pension for the tax if you pass away before taking your pension.
How much tax do you pay on pension savings above your lifetime allowance?
The rate of tax paid on pension savings above your lifetime allowance depends on how the money is paid to you. For instance, if you get it through pension payments or cash withdrawals, you will be charged a rate of 25%. However, if you get it as a lump sum, you will be charged a rate of 55%. Under what circumstances will you not be able to withdraw cash from a pension pot?
You cannot withdraw cash from a defined contribution pension pot if you have any two of the following:
- primary or enhanced protection covering a lump sum worth more than £375,000
- ‘lifetime allowance enhancement factor’ if your unused lifetime allowance is less than 25% of the cash you wish to withdraw
Under what circumstances can you lose enhanced protection?
You can lose enhanced protection or any type of fixed protection upon:
- Enrolling in a new workplace pension scheme
- Transferring money between pension schemes in a manner that does not meet the transfer rules
- Making new savings in a pension scheme
- Getting fixed protection and the value of your pension pot in any tax year grows at a higher rate than what the tax rules allow – also called ‘benefit accrual’
- Getting enhanced protection and the value increases more than the allowed amount in the enhanced protection tax rules when taking your pension benefits. This is called ‘relevant benefit accrual’
How can you report changes to HMRC?
You can report changes online or via post. Also, to ensure you do not lose protection, you can do two of the following:
- Opt-out of most schemes within a month
- Ask not to be enrolled in some schemes – however, your employer may need evidence of your lifetime allowance protection
Do you have the right to take your pension before 50?
Yes, you do have the right to take your pension before you are 50 under a pension scheme you joined before 2006. However, you may have a reduced lifetime allowance. Also, note that this only applies to people in certain jobs (i.e. modelling, professional sports and dance) who normally take their pension before they turn 55. Please also note that your lifetime allowance is not reduced if you are in a pension scheme for uniformed service which includes fire services, police, and the armed forces.
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