There has been a startling rise in the number of people who breach the annual pension allowance and who now risk HMRC clawing back tax perks, new figures show.
Between the tax years 2012‑13 and 2014‑15, the most recent for which data is available, there was a 79pc increase in the number of people who saved more in a pension in a single year than the rules allow.
This is more evidence that the pension system has become so complicated that the rules are having the perverse effect of discouraging prudent saving for later life.
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Pension company Royal London extracted the data on the “annual allowance” from the taxman using a Freedom of Information request.
It found that in 2012‑13, when the annual allowance was £50,000, 3,900 people reported that they had saved more than the limit. This rose to 5,800 in 2013‑14 and 7,000 in 2014‑15 – an increase of 79pc.
The true figure for breaches is likely to be far higher as HMRC’s statistics only show people who reported how much they had contributed to a pension.
Many others, particularly those in “defined benefit” pension schemes, will be unaware, because of employers’ contributions and the complicated methods used to calculate the total (see below).
Since 2014‑15 the annual allowance has been £40,000 for most people, down from a high of £255,000 as recently as 2010‑11. Ministers have steadily cut the allowance in a bid to save billions of pounds on pension tax incentives.
When you save into a pension, your contribution is topped up by the Government in line with your rate of income tax. So a higher-rate (40pc) taxpayer has to pay in only £60 to make a £100 pension contribution.
But this tax perk is subject to the £40,000 annual contributions allowance and the £1m lifetime limit on pension fund value. If HMRC discovers savings beyond these levels it will reclaim the tax relief it paid out.
There are fears that the Chancellor, Philip Hammond, may use this week’s Budget to announce further cuts.
Steve Webb, a director at Royal London and former pensions minister, warned that more people would break the limits next year.
The reasons are threefold.
Since April 2016, people who earn more than £150,000 have had the added complication of an annual allowance based on exactly how much they earn.
The “taper” reduces the limit to as low as £10,000 for people with taxable incomes of £210,000 or more. Second, the rules say you can “carry forward” three years of unused allowances. This means that someone who adds to their pension before the end of this tax year could go back to 2013‑14 and the higher £50,000 threshold. From next year, however, this will fall outside the three-year period.
Then there is the reduced “money purchase annual allowance” to consider. This affects anyone who has already taken money out of their pot under the “pension freedoms”. Previously this group could continue to save £10,000 a year into a pension, but this limit will fall to just £4,000 from April.
Mr Webb said: “Pension tax relief has been squeezed year after year, and these new figures reveal big growth in the numbers paying a tax penalty for being over the annual allowance.
“Savers have just a few weeks to use spare allowances from 2013‑14. It is worth anyone in this position finding out urgently how much they have spare from earlier years and if necessary to take impartial advice to help them plan the right level of pension contributions before the end of this tax year.”
Exactly how much can I put into a pension each year?
Within the annual allowance, you are restricted to saving no more than your “relevant earnings” for that year into a pension (subject to a universal minimum allowance of £3,600). Both these limits are gross, meaning that they include the tax relief added to your contribution.
So someone who earns £35,000 could pay a maximum of £28,000 themselves, which would be topped up with basic-rate tax relief of £7,000. Even if you are not earning you can save £3,600 a year into your pension, including tax relief, as long as your scheme operates on a “relief at source” basis.
“Relevant earnings” include basic pay, bonuses, commissions, sick pay, benefits in kind such as medical insurance, income from holiday homes and a whole host of other sources of income. All private pension savings count towards the annual allowance.
But people with entitlement to “defined benefit” schemes – where retirement income is guaranteed and based on salary and length of service – have an extra hurdle to clear. It is straightforward to see how much you have contributed to a “defined contribution” or “money purchase” pension plan, but the calculation for defined benefit schemes is extremely challenging.
It involves working out how much your entitlement has increased by since the last tax year, taking into account inflation, multiplying by 16 and noting any lump sums paid by the scheme. Ordinary savers should not attempt to do this calculation unaided.
Instead, write to all the schemes you have ever been a member of and they will do it for you. It may take your scheme some time to reply – so if you plan to take advantage of unused allowances this tax year, get in contact as soon as possible.
Once you have both defined benefit and money purchase pension contributions, use HMRC’s online tool to calculate how much of your annual allowance you have left to use.
An HMRC spokesman said: "99 per cent of people remain unaffected by the annual allowance charge, as they have either carried forward unused allowances from earlier years or have adjusted how much they put in their pension pots.
"The annual allowance and lifetime allowance help to manage the costs of the system and target the relief at those who need it most."