Pension savings — tax aspects

Types of pension schemes

There are two broad types of pen­sion schemes from which an indi­vid­ual may even­tu­al­ly be in receipt of a pen­sion:

• Work­place pen­sion schemes
• Per­son­al Pen­sion schemes.

A Work­place pen­sion scheme may either be a defined ben­e­fit scheme or a mon­ey pur­chase scheme.

A defined ben­e­fit scheme pays a retire­ment income based on final salary and years of ser­vice, while a mon­ey pur­chase scheme instead reflects the amount invest­ed and the under­ly­ing invest­ment fund per­for­mance.

The num­ber of defined ben­e­fit pen­sion schemes has declined in recent years in part due to the reg­u­la­tions imposed upon the schemes and the cost of such schemes to the employ­er. The major­i­ty remain­ing are in the pub­lic sec­tor. Each scheme sets its own rules with­in the per­mit­ted leg­is­la­tion so pro­fes­sion­al advice is always rec­om­mend­ed when deal­ing with such schemes. Detailed aspects are there­fore not cov­ered in this fact sheet.

All employ­ers are required to pro­vide a work­place pen­sion scheme due to auto-enrol­ment leg­is­la­tion and these are main­ly mon­ey pur­chase schemes. A sep­a­rate fact­sheet on auto- enrol­ment is avail­able.

A Per­son­al Pen­sion scheme is a pri­vate­ly fund­ed pen­sion plan but can also be fund­ed by an employ­er. These are also mon­ey pur­chase schemes. Self-employed indi­vid­u­als can have a Per­son­al Pen­sion.

To ben­e­fit from tax priv­i­leges all pen­sion schemes must be reg­is­tered with HMRC. For a Per­son­al Pen­sion scheme, reg­is­tra­tion will be organ­ised by the pen­sion provider.

We set out below the tax reliefs avail­able to mem­bers of a mon­ey pur­chase Work­place scheme or a Per­son­al Pen­sion scheme.

It is impor­tant that pro­fes­sion­al advice is sought on pen­sion issues rel­e­vant to your per­son­al cir­cum­stances.

What are the tax breaks and controls on the tax breaks?

An indi­vid­ual is enti­tled to make con­tri­bu­tions and receive tax relief on the high­er of £3,600 or 100% of earn­ings in any giv­en tax year. How­ev­er, tax relief will be restrict­ed for con­tri­bu­tions in excess of the annu­al allowance.

A mon­ey pur­chase scheme allows the mem­ber to obtain tax relief on con­tri­bu­tions into the scheme and tax-free growth of the fund. If an employ­er con­tributes to the scheme on behalf of an employ­ee, there is gen­er­al­ly no tax charge on the mem­ber and the employ­er will obtain a deduc­tion from their tax­able prof­its.

Under the cur­rent pen­sions regime, there are no lim­its on either the max­i­mum amount which can be invest­ed in a pen­sion scheme or on the total val­ue with­in pen­sion funds. How­ev­er, there are con­trols which lim­it the tax reliefs avail­able. First­ly, there are lim­its on the amount of tax relief avail­able to the mem­ber in mak­ing the con­tri­bu­tions to or accru­ing the ben­e­fits in their pen­sion schemes. Sec­ond­ly, there are tax free lim­its in access­ing those ben­e­fits.

Each indi­vid­ual has an annu­al allowance which sets the max­i­mum amount which can be invest­ed with tax relief into a pen­sion fund. The allowance applies to the com­bined con­tri­bu­tions of an employ­ee and employ­er (where rel­e­vant). Amounts in excess of this allowance trig­ger a charge.

When ben­e­fits are accessed, there is a lump sum and death ben­e­fit allowance which lim­its the amount which can be accessed tax free depend­ing on var­i­ous cir­cum­stances.

Key features of money purchase pensions

Methods of giving tax relief

Personal Pension Plans

Per­son­al con­tri­bu­tions are gen­er­al­ly payable net of basic rate tax relief, leav­ing the pen­sion scheme provider to claim the tax back from HMRC.

High­er and addi­tion­al rate relief is giv­en as a reduc­tion in the tax­pay­er’s tax bill. This is nor­mal­ly dealt with by claim­ing tax relief through the self assess­ment sys­tem.

There are spe­cial rules if con­tri­bu­tions are made to a retire­ment annu­ity con­tract. (These are old schemes start­ed before the intro­duc­tion of per­son­al pen­sions.)

Workplace pension schemes

There are two dis­tinct meth­ods which oper­ate and it is vital that the method apply­ing to par­tic­u­lar pen­sion arrange­ments is iden­ti­fied to ensure the cor­rect tax treat­ment. The alter­na­tive meth­ods are as fol­lows:

• A net of basic rate tax con­tri­bu­tion is deduct­ed from net pay of the employ­ee. The con­tri­bu­tion is then paid over by the employ­er to the pen­sion scheme. The basic rate is claimed back from HMRC by the pen­sion provider. High­er or addi­tion­al rate relief is claimed through the self assess­ment sys­tem.
• A gross con­tri­bu­tion is deduct­ed from the employ­ee’s gross salary and paid by the employ­er to the scheme. This low­ers the employ­ee’s PAYE tax bill and no fur­ther action is need­ed by tax­pay­ers as the cor­rect relief has been giv­en through the pay­roll.

One effec­tive route for an employ­ee to con­sid­er may be to enter a salary sac­ri­fice arrange­ment with an employ­er. The employ­er will make a gross con­tri­bu­tion to the pen­sion provider and the employ­ee’s gross salary is reduced. This will give the employ­ee full income tax relief (by reduc­ing PAYE) and also reduces Nation­al Insur­ance con­tri­bu­tions (NICs). How­ev­er, note that NIC relief on salary sac­ri­fice pen­sions is expect­ed to be lim­it­ed to £2,000 of con­tri­bu­tions from April 2029.

The annual allowance

The annu­al allowance is £60,000.

Any con­tri­bu­tions in excess of the £60,000 annu­al allowance are poten­tial­ly charged to tax on the indi­vid­ual as their top slice of income. Con­tri­bu­tions include con­tri­bu­tions made by an employ­er.

The stat­ed pur­pose of the charg­ing regime is to dis­cour­age pen­sion sav­ing in tax reg­is­tered pen­sions beyond the annu­al allowance. Most indi­vid­u­als and employ­ers active­ly seek to restrict pen­sion sav­ing so as to not exceed the annu­al allowance, rather than fall with­in the charg­ing regime.

Carry forward of unused annual allowance

A car­ry for­ward of unused annu­al allowance is avail­able for three years. This is use­ful for indi­vid­u­als who may have uncer­tain income streams or in sit­u­a­tions where the ‘own­er man­aged busi­ness’ com­pa­ny employ­er has fluc­tu­at­ing prof­its, allow­ing high­er con­tri­bu­tions to be made in a giv­en tax year where there is brought for­ward capac­i­ty avail­able.

For 2026/27, the unused allowance that can be brought for­ward is from 2023/24, 2024/25 and 2025/26, pro­vid­ed the indi­vid­ual was a mem­ber of a reg­is­tered pen­sion scheme at some time dur­ing the rel­e­vant brought for­ward tax year.

Unused annu­al allowance car­ried for­ward is the amount by which the annu­al allowance for that tax year exceed­ed the total pen­sion sav­ings for that tax year.

The annu­al allowance for the cur­rent tax year is always used before any unused allowance brought for­ward. The ear­li­est year unused allowance is then used before a lat­er year.

Lower annual allowance for those with high levels of income

Indi­vid­u­als with high lev­els of income may have their annu­al allowance reduced to lim­it the tax reliefs they obtain. This is known as taper­ing the allowance and applies where both their ‘adjust­ed’ and ‘thresh­old’ income exceeds cer­tain lev­els. Pro­fes­sion­al advice should be sought as to the detailed mean­ing of these terms.

How­ev­er, ‘thresh­old’ income means, broad­ly, a per­son­’s tax­able income and ‘adjust­ed’ income is’ thresh­old’ income plus pen­sion con­tri­bu­tions made by an employ­er.

Cur­rent­ly the thresh­old income lev­el is £200,000 and the adjust­ed income thresh­old £260,000. For every £2 of adjust­ed income over the adjust­ed income thresh­old, an indi­vid­u­al’s annu­al allowance is reduced by £1, down to a min­i­mum amount. The min­i­mum amount is cur­rent­ly £10,000.

The rate of charge if annual allowance is exceeded

The charge is levied on the excess above the annu­al allowance at the appro­pri­ate rate in respect of the total pen­sion sav­ings. There are exemp­tions from the charge in the case of seri­ous ill health as well as death.

The appro­pri­ate rate will broad­ly be the top rate of income tax that you pay on your income.

The lump sum allowance (LSA) and the lump sum death benefit allowance (LSDBA)

The annu­al allowance rules con­trol the lev­el of tax relief on con­tri­bu­tions to mon­ey pur­chase schemes and accrued ben­e­fits in defined ben­e­fit schemes whilst grow­ing your pen­sions tax sav­ings. The LSA and the LSDBA deter­mine the amount of ben­e­fits which can be accessed tax free depend­ing on set cir­cum­stances.

Indi­vid­u­als who have mon­ey pur­chase schemes and some defined ben­e­fit schemes can take a tax free lump sum when access­ing pen­sion benefits.This is referred to as the LSA. Gen­er­al­ly, this is lim­it­ed to 25% of the stan­dard LSDBA. The LSDBA is set at £1,073,100 so 25% is a max­i­mum of £268,275. Oth­er pen­sion income extrac­tion is sub­ject to nor­mal income tax rules. Where indi­vid­u­als are per­mit­ted to take a high­er lump sum, the excess above the lim­it is sub­ject to income tax.

Cer­tain indi­vid­u­als with pen­sion pro­tec­tion cer­tifi­cates are enti­tled to high­er tax free lim­its. This is a com­plex area and spe­cial­ist pro­fes­sion­al advice should always be tak­en.

In cer­tain sit­u­a­tions, the whole of the LSDBA can be accessed tax free. This occurs for exam­ple where an indi­vid­ual dies before the age of 75 or qual­i­fies due to seri­ous ill health.

Accessing pension benefits from money purchase schemes

Indi­vid­u­als have flex­i­bil­i­ty to choose how to access their pen­sion funds from the age of 55.

The options include:

• a tax-free lump sum of 25% of fund val­ue (as detailed above)
• pur­chase of an annu­ity with the remain­ing fund, or
• income draw­down (see below for options avail­able regard­ing flexi access accounts and lump sum pay­ments).

An annu­ity is tax­able income in the year of receipt. Sim­i­lar­ly any monies received from the income draw­down fund are tax­able income in the year of receipt.

Flexi access accounts and lump sums

Where a lump sum and annu­ity are not tak­en access to the fund can be achieved in one of two ways:

• allo­ca­tion of a pen­sion fund (or part of a pen­sion fund) into a ‘flexi-access draw­down account’ from which any amount can be tak­en over what­ev­er peri­od the per­son decides
• tak­ing a sin­gle or series of lump sums from a pen­sion fund (known as an ‘uncrys­tallised funds pen­sion lump sum’).

When an allo­ca­tion of funds into a flexi-access account is made the mem­ber typ­i­cal­ly will take the oppor­tu­ni­ty of tak­ing a tax-free lump sum from the fund.

The per­son will then decide how much or how lit­tle to take from the flexi-access account. Any amounts that are tak­en will count as tax­able income in the year of receipt.

Access to some or all of a pen­sion fund with­out first allo­cat­ing to a flexi-access account can be achieved by tak­ing an uncrys­tallised funds pen­sion lump sum.

The tax effect will be:

• 25% is tax-free (sub­ject to the lim­it detailed above)
• the remain­der is tax­able as income.

Money Purchase Annual Allowance (MPAA)

The gov­ern­ment is alive to the pos­si­bil­i­ty that those aged 55 and over could take advan­tage of the flex­i­bil­i­ties by ‘recy­cling’ their earned income into pen­sions and then imme­di­ate­ly tak­ing out amounts from their pen­sion funds. With­out fur­ther con­trols being put into place an indi­vid­ual could obtain tax relief on the pen­sion con­tri­bu­tions but only be taxed on 75% of the funds imme­di­ate­ly with­drawn.

A reduced annu­al allowance there­fore applies in cer­tain sce­nar­ios to lim­it the tax relief on con­tri­bu­tions. This is known as the MPAA and the allowance is cur­rent­ly £10,000 per tax year, over­rid­ing the nor­mal £60,000 annu­al allowance.

There is no car­ry for­ward of any of the MPAA to a lat­er year if it is not used in the year.

The main sce­nar­ios in which the reduced annu­al allowance is trig­gered are if:

• any income is tak­en from a flexi-access draw­down account, or
• an uncrys­tallised funds pen­sion lump sum is received.

How­ev­er just tak­ing a tax-free lump sum when funds are trans­ferred into a flexi-access account will not trig­ger the MPAA rule.