If you want to save for your retirement by investing your money in a pension, there are limits on how much you can pay in. The limit for the current year (2016-2017) is £40,000 or 100% of your salary, whichever is lower. There are also limits on how much you can invest over your lifetime. If you don’t have any earnings at all, you can still have a pension and pay into it.
You can pay up to £40,000 a year into your pension – what the limit means
At the moment you’re able to save either 100% of your salary or £40,000 a year (whichever is the lower amount) into a pension and get tax relief on money you pay in at your highest rate of tax.
SAVVY TIP: What it means in broad terms is that if you are a 20% tax payer, you will get tax relief at 20% and if you are a 40% tax payer you will get tax relief at that rate. It is a little more complicated if you pay tax at 45%. You can find out more about this in my article called Tax relief on pensions – how does it work?
- There is a cap on the amount you can save into your pension throughout your life From April 2016 the pensions lifetime limit is £1 million.
- You may be able to pay more than the annual limit. If you’ve not used your full pension allowance of £40,000 a year for the last three years you’ll be able to ‘carry forward’ this allowance.
SAVVY TIP: This means that if, for example, you’re able to save £50,000 into your pension one year and had only saved £10,000 into your pension the previous year, you’d be able to do so by ‘carrying forward’ some of your unused allowance. The jargon isn’t particularly user friendly but all it means is that you can potentially go back over the last three tax years and fill in any gaps. You must have paid the maximum amount into your pension in the current tax year before you are able to go back.
How it affects final salary pensions
Having said this pension rule is straightforward it is more complicated if you’re in a final salary scheme. That’s because the £40,000 limit doesn’t apply solely to money you have paid into your final salary or average salary pension. It is potentially a problem for someone on a higher salary or someone who has received a substantial pay rise.
This is an example of how it works.
- An employee earns £65,000 a year and has been a member of their final salary scheme for 20 years which will pay them 1/60th of their final salary for every year they’re a member, as a pension when they retire.
- At the moment she’s entitled to a pension of £21,667 a year. If she gets a pay rise of £5,000, at the end of that year the amount of pension she’ll be entitled to will have risen to £24,500 a year.
- Final salary contributions are worked out using a factor of 16. Because of the way final salary pensions work, the government has calculated that for every £1 of annual pension ‘benefit’ someone has earned, they’ll have paid in a contribution of £16.
- The pension benefit she’s earned is almost £3,000 The amount of pension benefit our employee has earned over the last 12 months is £2,883 (£24,500 – £21,667). If you multiply this by 16, you’ll arrive at the figure of £45,328, which is calculated as her pension contribution over the last year, which is over the limit of £40,000.
SAVVY TIP: HM Revenue and Customs has an annual allowance checker tool on its website, which you may find useful.
Lifetime limits on pension contributions
There is an overall limit on how much you are allowed to have in your pension(s) over your lifetime and still get tax relief on money you pay in. The limit was £1.8 million a few years ago but has gradually been coming down and in the tax year 2016-2017, it is £1 million.
- That means you can ‘only’ have up to £1 million in pensions. This limit applies to all the pensions you may have, except the state pension. If you have more than this in your pension fund, you may have to pay an excess tax charge called a Lifetime Allowance Charge.
- You can apply to protect your pension if it’s worth more than the lifetime allowance. The protection is called ‘Individual Protection’. There are different types of lifetime pension allowance protection, so it’s probably best if you talk about this with your independent financial adviser or if you ring the Pensions Advisory Service, which is a free to use service set up by the government and largely staffed by volunteers.
SAVVY TIP: The lifetime allowance reduced to £1.25 million in April 2014. And if your pension fund was above £1.25 million on 5th April 2014, you can apply for Individual Protection 2014. However, you must submit this application before April 5th 2017. There’s information about Individual Protection 2014 on the HM Revenue and Customs website.
There is more information about the Lifetime Allowance on the Gov.UK website.
SavvyWoman email newsletters: If you found this information useful why not sign up now to receive free fortnightly email newsletters with money saving tips and help? You can sign up at the top of any page on the website and your details won’t be passed to any other company for marketing purposes.