Pension changes

Tax relief pension contributions is restricted by reference to the annual allowance.

  • the annual allowance is currently £40,000*
  • the lifetime allowance is currently £1,000,000.

* This may increase in respect of any unused allowances in the previous three tax years. Conversely, it may reduce to £4,000 if the drawdown rights are exercised. For 2017/18 the annual allowance for those earning above £150,000 is to be reduced on a tapering basis so that it reduces to £10,000 for those earning above £210,000. For every £2 of income above £150,000, an individual will lose £1 of allowance.

Increasing pension flexibility

Under the current legislation when a member of a defined contribution pension scheme retires he or she can normally take up to 25% (in certain circumstances this can be significantly higher) of their pension pot as a tax-free lump sum. If the individual wishes to withdraw the balance of the fund as a lump sum, it will be taxed at income tax rates.

Those deciding to access their retirement funds are now free to take their entire pension pot, subject to tax at their marginal rate on the amount in excess of the 25% tax free lump sum. 

The amount of pension allowance available reduces where income, including company pension contributions exceeds £150,000. The allowance of £40,000 is tapered at a rate of £1 for each £2 of income over the limit, to a minimum amount of £10,000.

Annual allowance charge

The annual allowance refers to both the employee's and employer's contribution. From 2016 the system of checking the maximum contributions in a tax year has changed so that the amounts contributed in the year are tested against the limit of £40,000. 

Where someone does pay more than the relevant limit into a pension fund, they will still get tax relief at their highest rate of tax (40% or 45%), but they may have to pay an annual allowance charge (AAC).

For example, a company runs a pension scheme where employees contribute 8% of their salary and the employer agrees to provide twice this figure. Adrian earns £250,000 a year.

His contributions are therefore:
Adrian: 8% x £250,000     = £20,000
Employer 2 x £20,000       = £40,000
Total contributions         = £60,000

So Adrian is liable to the AAC – his annual allowance is tapered to £10,000, so his is taxed at 45% on a total of £50,000. He can elect for the pension fund to bear the tax if he prefers.

Bringing forward annual allowance

The £40,000 is an annual allowance. If the amount contributed in a year exceeds this, any unused allowance for the three previous years may also be used. The current year must be used first. Then the allowances for the three previous years, starting with the oldest for 2017/18 this will be £120,000.  

For example, Brenda is self-employed. Each year she decides how much to pay into her pension fund. She had a particularly good year in 2015/16. She makes these payments:


Tax year


2014/15 £24,000
2015/16 £36,000
2016/17 £38,000
2017/18 £100,000


All the contributions for years up to 2014/15 are covered by the allowances then in force. For 2017/18, we have to consider the £40,000 annual allowance. Her relief is calculated thus:


2017/18 contribution   £100,000
less: 2015/16 annual allowance (AA) £40,000 £60,000
less: 2016/17 AA (£40,000 - £38,000) £2,000 £58,000
less: 2015/16 AA (£40,000 - £36,000) £4,000 £54,000
less: 2014/15 AA (£40,000 - £24,000) £16,000 £38,000


This means that she must pay an AAC based on £38,000 excess pension contributions.

Defined benefit schemes

Some pensions are defined benefit schemes. These are also known as final salary schemes. Here the contribution is not defined; only the benefit is. The benefit is usually given as a tax-free lump sum and an annual pension. Each of these is calculated as a fraction of pensionable earnings. Such schemes are now largely only found in the public sector, though some long-serving employees in large companies may still be in such a scheme.

The annual allowance is considered according to the increase in value of the pension value during the year. The annual pension is calculated by multiplying the current value of the annual pension by a factor of 16. The opening value is increased by the rate of inflation as measured by the Consumer Price Index (CPI), not the Retail Prices Index (RPI).

Any amounts that relate to ill health cover are excluded.

For example, Colin is a teacher. His scheme provides for a lump sum of 3/80 of his pensionable earnings for each year of service, and an annual pension based on 1/80 for each year of service. At the start of the year he was earning £50,000 after 20 years' service. During the year, he was promoted to a salary of £60,000. The CPI for the year was 3%.


Opening value of pension fund      
Annual pension: 20/80 x £50,000 =  £12,500  
Multiplied by a factor of 16 =    £200,000
Lump sum: 20 x 3/80 x £50,000 =      £37,500
Total value of pension fund      £237,500
uplifted by 3% CPI (i.e. multiplied by 1.03)      £244,625
Closing value of pension fund      
Annual pension: 21/80 x £60,000 = £15,750  
Multiplied by a factor of 16 =    £252,000
Lump sum: 21 x 3/80 x £60,000 =     £47,250
Total value of pension fund     £299,250
Increase in value of pension fund      
Closing value     £299,250
less opening value     £244,625
Increase in value - deemeded contribution     £54,625


So Colin could be liable to the AAC as his pension has increased by more than £50,000 during the year. He may be surprised that a £10,000 a year pay rise generates a £54,625 increase in pension valuation.

In practice, he is likely to have unused allowances from the previous years and so will pay no extra tax. Nevertheless, this example shows that defined benefit schemes can trigger the tax charge even on fairly low sums.

Calculating the annual allowance charge

The annual allowance charge is added to the taxpayer's other taxable income and taxed accordingly.

For example, Diana has reduced net income of £130,000 for the year. This figure is her taxable income less her personal allowance and any other reliefs and allowances.

Her annual allowance charge is £40,000. This is the amount of her pension contributions for the year less £40,000 for the current year and less any unused amounts from the three previous years.


Her tax is:  
Balance of the 40% band: £150,000 threshold - £130,000 = £20,000  
Tax at 40% = £8,000
Balance taxed at 45%: (£130,000 + £40,000) - £150,000 = £20,000  
Tax at 45% = £9,000
Additional tax £17,000


So Diana will pay an extra £17,000 tax in respect of her pension contributions in addition to her other tax liabilities.

Points to note

The main points to note are:

  • taxpayers continue to receive tax relief at their full marginal rate on contributions, but may have to pay tax on an annual allowance charge
  • in general, this does not affect taxpayers whose pension fund contributions are less than £40,000 a year provided their income does not exceed £150,000
  • if contributions do exceed £40,000, any unused allowance for the three previous years may be used
  • defined benefit schemes can result in large increases in pension fund values on relatively small increases in pay
  • defined benefit schemes have an obligation to report fund values to members
  • contributions that arise on redundancy are included in the reckoning
  • tax relief is given on the amount paid in the tax year
  • the annual allowance is tested against the amount contributed in the pension input period, which from April 2017 is always the same as the tax year.

There are many other implications that may need to be considered. These include converting a final salary scheme to a money purchase scheme, adjustments for Gift Aid payments, and transitional provisions for certain high value existing schemes. There are also administrative provisions and anti-avoidance provisions that need to be considered.

There are provisions that allow pension funds to smooth out any "spikes" in pension fund accruals, subject to anti-avoidance provisions, and in some cases the tax charge arising on the annual allowance charge can be paid by the fund, reducing the value available at retirement.

Lifetime allowance

The lifetime allowance is only tested against the total pension savings when the individual takes some or all of his pension - known as a Benefit Crystallisation Event. The value of the fund is tested against the limit, and if appropriate a tax charge is levied. However, individuals can seek various types of protection in relation to this tax charge, but generally speaking will not be permitted to make any further contributions to any form of pension arrangement after they have elected for protection.

We can advise on all these other implications, in addition to explaining any of the above matters as they relate to your circumstances.

It should also be noted that this is not the only change in pensions being introduced. Other changes include:

  • From 2017 the state pension age for women is 63
  • Between April 2017 and November 2018 state pension age will rise to 65 for women
  • After this, between October 2018 and October 2020, the state retirement age for both men and women will rise to 66
  • From 2026 to 2028 the state pension for both men and women will start rising to 67
  • After this the government will review the state pension age every 5 years based on life expectancy. Based on figures from DWP this could result in the state pension age increasing to 68 from the mid 2030s and to 69 in the late 2040s.

We can advise on all these changes and on other pension matters.