There are two main pension allowances that you should be aware of that have tax implications.
You can pay up to £40,000 a year into a pension and earn tax relief on this, which is known as your Annual Allowance. If you pay more than the Annual Allowance into your pension, you’ll have to pay what’s known as an Annual Allowance charge. HMRC has an Annual Allowance calculator to help you work out whether you have to pay tax on your pension savings.
The Annual Allowance charge isn’t a fixed rate – the amount you’ll pay will depend on which income tax bracket you’d fall into if your excess pension savings are added to any other taxable income you get. So, for example, the charge could be 20%, 40% or 45% of any pension savings you made above the Annual Allowance, depending on your circumstances.
In addition, there’s the Lifetime Allowance, which is the total amount that you can save into your pension over your lifetime without facing a tax charge. The Lifetime Allowance is £1,073,100 in the 2021/22 tax year. If the value of your pensions is higher than the Lifetime Allowance, you’ll have to pay a tax charge on anything above it, and you should get a statement from your pension provider which will show how much tax you owe. The amount you’ll be charged depends on how you’ve chosen to take money out of your retirement savings.
For example, if you make cash withdrawals or receive the money as pension payments, you’ll be taxed an additional 25% on top of any regular tax payable on your pension income. Any amount over your Lifetime Allowance which you take as a lump sum, however, will be taxed at a rate of 55%.
So, if you pay tax at the higher rate and are expected to get £10,000 a year in income from your pension, the Lifetime Allowance charge would reduce this to £7,500 a year. After income tax at a rate of 40%, you’d be left with an income of £4,500.
You can read more about these allowances in our article How do pension allowances work?