Pensions tax relief
Understanding the Lifetime and Annual Allowances
Members receive tax relief on their pension contributions to encourage saving for retirement. This is via either net pay for contributions to workplace pensions from payroll or relief at source for contributions to personal pensions.
This is because of a principle that has existed since the 1921 Finance Act that pension contributions and investments are exempt from tax but the resulting pension in payment is tax deductible.
The Annual Allowance and Lifetime Allowance were introduced on 6 April 2006 to limit the cost of pensions tax relief to the Treasury.
Although this system was introduced as a part of a project to simplify pensions, alterations by successive governments have made the system far more complicated!
Lifetime Allowance (LTA)
The Lifetime Allowance is an individual’s lifetime limit on pension savings held in the UK. The allowance was originally set at £1,500,000 for 2006-07. The allowance was increased annually and reached a high of £1,800,000 for 2010-11 and 2011-12.
The allowance was subsequently reduced to £1,500,000, £1,250,000 and finally £1,000,000 for 2016-17. Lifetime allowance protections were introduced by the Treasury each time the allowance was reduced.
The allowance is now set to increase in line with the consumer prices index (CPI) from 2018-19. The 2018-19 allowance is £1,030,000.
Annual Allowance (AA)
The Annual Allowance is the annual limit on pension savings aligned from 2016-17 with the tax year. The standard annual allowance has been £40,000 since 2014-15. There is also a Tapered Annual Allowance for high earners.
Members of defined contribution schemes have their employee contributions assessed against the allowance, while members of defined benefit schemes have their pension growth in the tax year assessed against the allowance.
The Treasury has a formula for calculating of pension growth in a year for the purposes of the annual allowance.
The annual and lifetime allowances are particularly complex for higher earners with defined benefit pension schemes. As a result of these restrictions, more and more Prospect members are finding themselves facing potential tax charges.
We have a short briefing note outlining the steps members should take if they’ve received a letter from their pension scheme indicating that they have exceeded the Annual Allowance. This is available here.
We also have a comprehensive briefing note on the current pensions tax relief system, covering the Lifetime Allowance, standard Annual Allowance and Tapered Annual Allowance.