The Annual Allowance: are you affected?
The Annual Allowance is one of the most complex areas of pension taxation, particularly for members of defined benefit schemes like the Teachers’ Pension Scheme, NHS pension scheme, and Local Government Pension Scheme. Recent changes to allowance levels and the treatment of higher earners mean many scheme members have been caught off guard by unexpected tax charges running into thousands of pounds. Understanding how these rules work, recognising when you might be affected, and knowing your options can help you avoid unnecessary charges and protect your retirement planning.
What is the Annual Allowance?
The Annual Allowance determines the maximum amount that may be contributed to a pension before a tax charge must be paid. This tax charge is known as the Annual Allowance charge.
Pension contributions are measured against the Annual Allowance differently depending on whether the pension scheme is a defined contribution scheme (such as a group personal pension) or a defined benefit scheme (such as the Teachers’ Pension Scheme, NHS Pension Scheme, Local Government Pension Scheme).
The Annual Allowance was £60,000 in the 2024/25 tax year and pension schemes have a legal responsibility to notify their members if they have reason to believe that they may have breached the standard Annual Allowance. The deadline to issue pension savings statements for the 2024/25 tax year was 6 October 2025. Individuals that exceed the Annual Allowance can carry forward any unused Annual Allowance from the previous three tax years.
If an individual’s total taxable income exceeded £200,000 in the 2024/25 tax year, the standard Annual Allowance may be reduced, and these individuals may not receive a pension savings statement automatically from their pension scheme to highlight that there is a potential tax charge. (see below for further information).
Basis of the Annual Allowance calculation
Pension contributions are measured against the Annual Allowance differently depending on the type of pension scheme in question. Contributions to defined contribution pensions such as personal pensions (including the Teachers’ Pensions AVC Scheme with Prudential) are simply valued as the total of all gross payments to the scheme, whether made personally, or by someone else, such as an employer.
Contributions to defined benefit pension schemes, where the value of the pension benefits is specified are measured very differently. Instead of the actual contributions made (e.g. member/employer payments), the increase in the value of total pension benefits from one financial year to the next is what determines the level of deemed contribution, or pension input amount (PIA).
This is calculated by finding the capital value of the accrued pension income and any automatic lump sum immediately before the start of the pension input period (PIP), this is the ‘opening value’. The benefits are then revalued, to account for inflation for that period, and this value is compared with a similar calculation on the final day of the PIP, the ‘closing value’.
Whenever inflation reduces significantly, this typically results in a lower PIA. The measure of inflation used to revalue defined benefit pension schemes in the 2024/25 tax year is much lower than previous tax years, which has resulted in lower PIA calculations. However, anyone who has received a significant pay increase or had taxable income above £200,000 in the 2024/25 tax year may have an Annual Allowance charge to pay.
Any additional pension benefits purchased in the scheme (such as Additional Pension Benefit or Past Added Years in the Teachers’ Pension Scheme) must also be taken into account, with the deemed contribution relating to the increase in the paid-up value of any additional pension during the PIP.
Reduction in the Annual Allowance for higher earners
Pensions tax relief is restricted further through a tapered reduction in the Annual Allowance for individuals who have taxable income (referred to as Threshold Income), excluding pension contributions other than those via salary sacrifice in excess of £200,000 and Adjusted Income (including the value of any pension contributions) of over £260,000.
For someone meeting these criteria the Annual Allowance will be reduced by £1 for every £2 of Adjusted Income above £260,000. The reduction is capped so that the allowance won’t fall below £10,000 for those with Adjusted Income over £360,000.
The main constituents of Adjusted Income are:
- An individual’s net income (i.e. taxable income reduced by deductions listed in section 24 of the Income Tax Act 2007, which are reliefs such as trading and share loss relief), plus
- The value of any individual pension contributions deducted by an employer under the net pay system, plus
- The value of any employer pension contributions for the tax year.
The main constituents of Threshold Income are:
- An individual’s net income, plus
- The amount of any employment income given up for pension provision as a result of salary sacrifice made on or after 9 July 2015 (anti-avoidance measure), less
- Gross pension contributions paid by an individual under the relief at source method.
Monitoring pension contributions
There is no automatic notification system if an individual has breached their available Annual Allowance. Pension schemes have a legal responsibility to notify their members if they have reason to believe that they may have breached the standard Annual Allowance.
This notification takes the form of a Pensions Savings Statement that is issued annually, usually during the autumn. Pension schemes will not be aware of other pension arrangements, for example AVCs with the Prudential, and it is each individual’s personal responsibility to monitor their total pension contributions to all registered pension schemes in each tax year and to report any liabilities to HMRC.
Payment of the Annual Allowance charge
Any pension contribution in excess of the available Annual Allowance, including any available carry forward allowances, must be disclosed to HMRC via a self-assessment tax return. The deadline is the 31st January following the end of the relevant tax year.
The excess pension contribution is added to other income. After the deduction of any reliefs allowed for under s24 ITA 2007 (eg. charitable contributions and teachers pensions schemes or other pension contributions made personally) the excess is taxed at an individual’s highest marginal rate of income tax.
In 2024/25, any excess pension savings may therefore be charged to tax in whole or in part at 45%, 40% or 20% depending on other taxable income and the amount of the excess pension contribution.
For example, an excess contribution of £30,000 for an individual whose reduced net income is £110,000 would be calculated as follows:
Scheme pays option
It is possible for a member of a pension scheme to elect for the scheme to pay some or all of the Annual Allowance charge.
The Scheme Pays option may not be available on any tax liability relating to a contribution in excess of a tapered Annual Allowance, and below the standard Annual Allowance.
When the scheme pays option is selected there will be an appropriate reduction in pension benefits, based on criteria laid down by the Government Actuary’s Department.
Any reduction in benefits will be recorded as a debit against the member’s record by the pension scheme and will be re-valued each year by inflation. The debit will reduce future pension and lump sum payments but will not affect dependants’ benefits.
Members must inform their pension scheme of their intention to use scheme pays prior to the relevant deadline. This is typically 31st July in the year following the end of the tax year to which the Annual Allowance charge relates but may differ depending on the scheme and the type of election being made.
How Moore Kingston Smith can help
At Moore Kingston Smith, our employee benefits team offer services to assist pension scheme members with calculating their Annual Allowance charges. These services include the use of bespoke modelling tools to:
- Confirm Pension Savings Statement pension input amount values.
- Calculate the Annual Allowance carry forward available from the previous three tax years.
- Calculate the excess pension contribution within a tax year.
- Forecast future Annual Allowance charges.
- Develop strategies to mitigate future potential Annual Allowance charges.
Please contact us if you require any support with your Annual Allowance calculations or are concerned about a potential Annual Allowance charge.
