What is my annual pensions allowance?
I’m currently drawing down from a defined benefit pension scheme and I’m looking to set up a SIPP. Please can you tell me what my annual allowance will be – is it £40,000 or £4,000?
Tom Selby, AJ Bell Senior Analyst says:
The UK pensions annual allowance for 2020/21 is £40,000. However, not everyone can pay this much into their retirement pot during the tax year.
First of all, personal pension contributions which you can receive tax relief on are limited to 100% of your ‘UK relevant earnings’. Relevant earnings include things like your employment income, bonuses and taxable benefits in kind.
Note that it is only personal – and not employer – contributions that are limited to 100% of relevant earnings.
If you have no relevant earnings you can still make up to £3,600 of personal pension contributions – inclusive of basic-rate pension tax relief – during the tax year.
You mention a £4,000 allowance in your question, which I suspect is a reference to the ‘money purchase annual allowance’ (or MPAA). The £4,000 MPAA kicks in when someone ‘flexibly accesses’ their defined contribution (DC) pension from age 55.
There are a number of ways you can trigger the MPAA, including by receiving taxable income from your DC pension through drawdown, taking an ad-hoc lump sum, exceeding your maximum income limit in ‘capped drawdown’ or buying a ‘flexible’ annuity.
The MPAA will not be triggered if you buy a lifetime annuity or if you take income from a defined benefit (DB) pension. So, as you are taking a scheme pension from a defined benefit scheme it shouldn’t affect you.
Finally, for very high earners the annual allowance may be reduced by the annual allowance ‘taper’. There are two income measures that matter for the taper – ‘threshold income’ and ‘adjusted income’.
If you have threshold income above £200,000 and adjusted income above £240,000, your annual allowance will reduce by £1 for every £2 of adjusted income above £240,000, to a minimum of £4,000 for those with adjusted income of £312,000 and above.
Broadly speaking threshold income is your taxable income minus personal pension contributions, while adjusted income is taxable income plus employer pension contributions.
You can read more detail about how the annual allowance taper works in this AJ Bell guide.
One last thing to remember is ‘carry forward’, which could allow you to use unused annual allowances from the three previous tax years in the current tax year, as long as you were a member of a pension scheme.
Your personal contributions will still be restricted to 100% of relevant earnings, but using carry forward could allow you to benefit from up to a total allowance of £160,000 in the current tax year (3 x £40,000 allowances from the last three tax years plus £40,000 from the current tax year).
Again, you can read more about how carry forward works in detail here.
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