In 2023, then chancellor Jeremy Hunt made a significant change by increasing the pensions annual allowance from £40,000 to £60,000. However, an unexpected trend has emerged since then: despite the increase, the number of savers exceeding the limit has been on the rise.
During the 2024-25 tax year, a total of 30,440 savers exceeded their annual allowance, marking a 22 per cent increase from the previous year. Not only did the number of breaches increase, but the total value of these excess contributions also surged by 33 per cent.
Financial planning partner David Little from Evelyn Partners suggests that the tapering of the allowance for high earners might be the main reason for this increase in breaches. The headline figure of £60,000 could be misleading for high earners, as the tapering mechanism kicks in once an individual’s income exceeds certain thresholds.
The tapering rules are based on two factors: the individual’s threshold income (income minus pension contributions) must be above £200,000, and their adjusted income (income plus employer pension contributions) must exceed £260,000. If these criteria are met, the annual allowance starts to decrease by £1 for every £2 of income above £260,000, potentially falling as low as £10,000.
Little points out that the combination of elevated inflation and fluctuating income levels could have led to savers unintentionally breaching their allowance limits. For individuals with defined-benefit (DB) pensions, tracking their allowance can be even more challenging, as DB pensions are measured based on the growth in the value of the promised pension rather than contributions.
To avoid exceeding the allowance limit, savers are advised to proactively monitor their pension contributions, estimate their total income including bonuses, and check if any unused allowances can be carried forward from previous tax years. If they find themselves facing a tax charge for exceeding the limit, they can inquire about Scheme Pays, where the pension scheme may cover some or all of the tax charge in exchange for reducing future pension benefits.
It’s crucial for individuals to carefully consider their options before halting pension contributions, as they may still benefit from employer contributions and investment growth or DB accrual. Ultimately, staying informed and proactive in managing pension contributions can help avoid unexpected tax charges and maximize retirement savings.