How to make the most of your pension allowances before April

Let’s take a walk down memory lane and hark back to the 2010-11 tax year, a time when pension allowances were strikingly different.

The annual allowance, the maximum you can pay into pensions every year and get tax relief, was a whopping £255,000, while the lifetime allowance, the limit your pension savings can be worth without being hit with pernicious tax charges, was £1.8million.

But over the subsequent 12 years the government delivered major cuts to these allowances, penalising savers in the process.

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By the 2022-23 tax year, the lifetime allowance had been slashed to £1.07 million. According to reports, more than a million savers were on track to breach it - including NHS doctors, some of whom were retiring early to avoid a potential 55% tax penalty.

The annual allowance, meanwhile, was chopped to £50,000 from April 2011, and to £40,000 in 2014. It remained at this level for nine years.

You could argue that £40,000 was still generous – few have the financial muscle to plough this sum into their pension every year. But the direction of travel prompted concern.

The introduction of two new pension allowances in the mid-2010s placed a further squeeze on some savers. The money purchase annual allowance (MPAA), and tapered annual allowance (taper), restrict tax relievable pension contributions for retirees and high earners, respectively. Both allowances started at £10,000 but had been sliced to £4,000 by 2022-23.

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In March last year, at his Spring Budget, Jeremy Hunt shook up the pensions landscape. The chancellor announced the lifetime allowance will be abolished from April 2024 (though the tax charge for exceeding it was removed from April 2023), and raised all three annual pension allowances.

The table below shows the trajectory of the four allowances since 2010-11.

From April 2023, the standard annual allowance was raised to £60,000, while the taper and MPAA were restored to £10,000.

This means that, compared to the previous tax year, you now have extra scope to save into a pension and get tax relief. Plus, as the lifetime allowance has been kiboshed, you can invest without the fear of being hit with heavy tax penalties once you draw from your pot. The one sting in the tail is that the maximum tax-free cash has been frozen at £268,275 – 25% of the previous lifetime allowance.

How can you make the most of your pension allowances before 5 April?

Pensions are a great way to trim your tax bill, and give your retirement savings a boost. Let’s look at each annual allowance, detail who it affects, and explain what you can do.

• Work out your annual allowance

Most workers can contribute the lower of 100% of earnings or £60,000 into a pension every year and get up-front tax relief at their marginal rate. The allowance includes any pension payments from third parties, such as your employer.

For example, if you earn £35,000 a year, that’s your annual allowance. But if your total earnings are £70,000, your allowance is £60,000.

How does the up-front tax relief work?

Well, if you make personal contributions, such as through your interactive investor self-invested personal pension (SIPP), you get an immediate 25% boost in the form of a government top up. Higher and additional rate taxpayers can potentially reclaim an extra 20% or 25% of gross contributions via their tax return.

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Even if you’ve earned nothing this tax year, you can still pay into a pension and get tax relief. The maximum you can contribute is £2,880, which the government will top up to £3,600.

This is not only useful for those not working but who would like to beef up their pension savings, but also to support younger generations.

You can save £2,880 (again topped up to £3,600) into a pension every year on behalf of a child and grandchild, giving them a head start on their retirement savings. This great article by Faith Glasgow explains that with a bit of planning, you could help your child to become a pension millionaire.

• Check if you’re restricted by the MPAA

With the MPAA rising from £4,000 to £10,000 in April, those already retired have more capacity to top up their pension and get tax relief.

The higher allowance might be useful if you’ve returned to the workforce and these earnings have tripped you into a higher tax bracket, or you wish to capitalise on the IHT-swerving perks of pensions.

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But it’s important to check whether the MPAA affects you. It only typically impacts those who have made flexible income withdrawals from pensions.

So if you’ve drawn some or all your 25% tax-free cash and don’t make flexible withdrawals, or have used the remaining pot to buy an annuity, the MPAA isn’t triggered. This is also the case if you’ve taken a defined benefit (DB) pension.

• High earners need to watch the taper

The taper is unequivocally the most complex of the pension allowances. That said, it only affects 0.5% of the population.

In terms of how it works, your annual allowance reduces by £1 for every £2 you earn above £260,000, to a minimum of £10,000.

As an example, if you earn £300,000 a year, your annual allowance will drop from £60,000 to £40,000.

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While the new higher allowance will benefit those affected by the taper, the calculation here can get a bit complicated. It’s worth seeking professional advice from a regulated financial planner to make sure your contributions stay within the limits.

• Carry forward if you can

In some instances, you can exceed your annual allowance and still get tax relief.

This is due to something called carry forward, which allows you to tap into any unused allowances from the previous three tax years. But once again, the 100% of earnings rule still applies.

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Importantly, carry forward cannot be used if you’ve triggered the MPAA, but can be used for those restricted by the taper.

While only a fraction of the working population is likely to benefit from carry forward, it can be useful if you’ve received a sizeable windfall or you’re looking to make up for lost time with retirement fast approaching.

• Retain key benefits and allowances

In some cases, topping up your pension between now and April can bring some additional benefits.

If you’re a parent of young children and either you or your spouse earns more than £50,000 a year, or you earn more than £100,000, the arguments of paying into a pension become stronger.

In short, for every £100 you earn above £50,000, you’re hit with a 1% charge on child benefit payments, which means the cash sum is effectively wiped out once earnings hit £60,000.

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And for every £2 you earn above £100,000, your personal income tax allowance, currently £12,570, reduces by £1. This means that once earnings exceed £125,140, you pay tax on everything.

But paying into a pension can help you avoid the High-Income Child Benefit Charge or retain your personal allowance, as it reduces what’s called your “net adjusted income”.

For instance, if you earn £55,000 and pay £5,000 into a pension, your income falls to £50,000.

The combination of tax relief and retained benefits or allowances, could result in an effective tax saving of 60%. What’s more, your retirement savings will get a healthy boost.