How much can I pay into my pension?

In order to prepare for later life, we’re often told to put aside as much as possible into our pension pots. But is it possible to overpay into our pensions? And can this have a knock-on effect when it comes to the tax we pay?

It’s important to know the rules around how much you can pay into your pension, and the tax considerations. 

What is the pension annual allowance?

In the UK, there is no limit on the amount of money taxpayers can pay into their pension annually. However, there is a limit to how much you can contribute tax-free. 

Whenever you pay into your pension, you get tax relief from the government. How this tax relief manifests will depend on your tax banding and your pension scheme. Most employers operate a salary sacrifice arrangement which provides you with income tax and NI relief at source regardless of your tax-banding. However, if you pay privately into a pension, the tax treatment is slightly different. Basic rate tax relief (20%) is applied to the contribution, however, for higher and additional rate taxpayers, they are still owed a further 20% and 25% tax relief, respectively. This relief must be reclaimed by the individual separately via a self-assessment tax return.  

The pension annual allowance is currently £40,000. This allowance is inclusive of  personal contributions, employer contributions and any government tax relief you receive. Contributions which exceed the Annual Allowance  will be subject to a tax charge, known as an Annual Allowance charge, which is  the removal/reclaim of any tax relief applied to the excess.  

Can you carry forward unused annual pension allowance? 

In certain circumstances, you may be able to carry forward annual pension allowances from up to three previous tax years. In this instance, you are given permission to exceed your annual allowance and still receive tax relief. 

  • To benefit from carry forward, you must meet the following conditions: 
  • You have been a member of a UK pension scheme (not including State Pension) in each of the years you wish to carry forward from. 
  • You must have fully utilised your available AA in the current tax year first 
  • Unused Annual Allowance is then drawn from the furthest year first I.e. 2019/20 is the third year back from the current tax year. 
  • You cannot contribute more than 100% of your relevant UK earnings in a given tax year. I.e. if your gross earnings are £60,000, this would be the total pension contribution you can make in the current tax year, regardless of whether your available carry forward allowances are higher. 

How much should I pay into my pension? 

How much you should pay into your pension will depend on a number of factors, including your age, earnings and goals. 

Common advice for determining your ideal pension contributions is to aim to save up 10 times your average salary by the age of retirement. So, if your average salary is £40,000, it’s recommended that you aim for a pension pot of around £400,000. 

Others say that you should aim to save 12.5% of your monthly salary. If your employer is matching your personal contributions, then this can be reduced to 5% making it a very realistic figure to aim for.  

Beyond these generalised recommendations, however, there are a number of factors influencing the amount you should pay into your pension. Below are some of the most important: 

  • What is your goal income for retirement? -  
  • What age?/Timeframe? Health/longevity? Income/expenditure requirement? Other assets/income?  
  • This is basically how much you will need to maintain your current lifestyle. To get an idea of this, you can add up your current monthly expenses, then deduct any that will no longer apply by the time you reach retirement (mortgage, commuting costs, etc.) 
  • Extra money you anticipate needing - This is money for things like holidays, home renovations, or supporting family members financially. 
  • Factor in cost of living increases - The cost of living typically doubles every 25 years, so it’s worth incorporating this into any financial projections. 
  • Length of retirement - This is a combination of the age you intend on retiring at and how long you expect to live. The latter is obviously a little less predictable, but you can find a good estimate by considering lifestyle factors and family history. 
  • How much state pension you will receive - If you qualify for the full new state pension, you will receive £185.15 per week, or £9,628 a year for the tax year 2022/23 This is likely not enough to live on but could be a good top up your personal pension pot. 

Despite the pension annual allowance of £40,000, if you’re getting close to retirement age, it may still be worthwhile putting aside as much as possible even if you will be liable to pay an annual allowance charge. You can weigh up the charge proportional to your contributions to assess whether it’s a financially beneficial decision or not. Pension can be access from age 55 (57 from 2028), bear this in mind when investing and make sure you have other funds you can access in the short and medium term, if retirement is a long way off.  

Does my employer have to pay into my pension? 

By law, all employers must offer a workplace pension scheme. This means that three bodies contribute to your pension: you, your employer, and the government. 

If you qualify for automatic enrolment, then your employer is obliged to enrol you into a pension scheme and make contributions to your pension. If your employer is not obligated to enrol you by law, then you can still opt into their pension scheme — and your employer cannot stop you. 

However, they do not have to contribute if you earn an amount equal to or less than £520 a month, £120 a week or £480 over 4 weeks. 

Once you’re enrolled in your employer’s pension scheme, they must, by law, punctually pay at least the minimum contributions to the pension scheme, allow you to opt out of the pension scheme and refund you the money you’ve paid into it (if you do so within 1 month). Plus, they have to allow you to re-join the scheme at least once a year if you have opted out. 

Under no circumstances can your employer try to encourage or coerce you into opting out of the scheme, terminate your employment or discriminate against you if you decide to stay in a workplace pension scheme. Nor can they insinuate that somebody is more likely to get hired if they choose to opt out of the pension scheme or end a workplace pension scheme without automatically enrolling all members into another one. 

So in summary, there is no limit to how much you can pay into your pension. However, the limit for tax free contributions is £40,000 annually, which is known as the pension annual allowance. Exceed this, and you’ll be expected to pay an annual allowance charge. Depending on your income and your pension plans, this can be a deterrent to paying more than the pension annual allowance.

How can we help? 

Here at The Private Office, our pension planning specialists can help provide you with clear advice on your options for your pension, tailored to your unique circumstances and individual needs. Get in touch to arrange a free consultation.

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Please note: A pension is a long term investment, the value of investments can fall as well as rise. You may not get back what you invest. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation, as these may be subject to change. This article is for information purposes only and does not constitute personalised advice.

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