Guide to UK Pensions and Tax

For investors planning a secure and tax-efficient retirement, UK pensions remain one of the most powerful tools available. Pension contributions not only reduce your taxable income today but also allow your investments to grow free from income tax and capital gains tax over the long term.

To make the most of these advantages, you need to understand how the rules around pension tax relief and allowances have changed—particularly after the significant reforms introduced between April 2023 and April 2025.

With the abolition of the Lifetime Allowance, the introduction of new lump sum limits, and an upcoming shift in Inheritance Tax treatment from 2027, it’s never been more important to stay informed.

This guide provides a clear, practical breakdown of the rules, limits, and planning opportunities currently in effect.

How Tax Relief Works on Pension Contributions

When you contribute to a UK registered pension, the government refunds the income tax you originally paid on those earnings. You receive it as a credit into your pension—boosting your saving automatically.

• Basic-rate taxpayers (20%) receive the relief “at source”—it’s added by the pension provider.

• Higher-rate (40%) or additional-rate (45%) payers must claim the extra relief via self-assessment.

Example: If you earn £50,000 and contribute £10,000 gross, a basic-rate saver pays £8,000 net and the pension provider claims £2,000 from HMRC. If you're a 40% taxpayer, you can claim an extra £2,000 via tax return, making your net cost £6,000.

Tax relief is only available on “qualifying earnings”—employment income, self‑employed profits, bonuses, overtime, redundancy taxed over £30,000. Non‑qualifying income such as dividends, rental income, and State Pension do not count.

Annual Allowance — How Much You Can Contribute Tax‑Efficiently

From 6 April 2023 onwards through 2025/26, the standard annual allowance (AA) is £60,000.

• Includes all contributions: yours, employer’s, and any third-party top-ups.

• Up to 100% of qualifying earnings, or £3,600 if earnings are below that.

If you exceed your AA, the excess may be subject to an annual allowance charge and must be reported in a tax return.

Carry‑Forward of Unused Annual Allowance

You can carry forward unused allowance from the prior three tax years. For instance, if you used only £40,000 of allowance in each of the prior two years (£20,000 unused each year), you could contribute up to £80,000 in 2025/26 tax-free.

Carry‑forward is automatic and requires scheme membership in those years.

Money Purchase Annual Allowance (MPAA)

If you have flexibly accessed a defined contribution pension (e.g. income drawdown or lump sums) since 2015, the MPAA applies, limiting contributions to £10,000 per year.

Contributions above MPAA in that tax year will be taxed. Meanwhile, the remaining AA can apply to other pension types via a £50,000 alternative allowance framework.

Tapered Annual Allowance for High Earners

Higher earners face a sliding reduction of AA:

• If your adjusted income exceeds £260,000, AA is reduced by £1 for every £2 over.

• Threshold income (before pension deductions) above £200,000 also triggers taper.

• Minimum AA is £10,000 for those earning £360,000 or more.

  
  

Lifetime Allowance Abolished — What Replaced It?

The pension Lifetime Allowance (LTA)—the £1,073,100 limit beyond which tax charges applied—was formally abolished:

• From 6 April 2023, charges for exceeding LTA were removed.

• From 6 April 2024, the limit was fully removed from legislation.

No tax penalty now applies simply for having more than £1.073 million in a pension.

New Allowances – Lump Sum & Death Benefit

Although the LTA is gone, limits remain in place for tax‑free cash:

• Lump Sum Allowance (LSA): Tax‑free lump sum limit is £268,275, usually 25% of unused pensions, applied across all schemes.

• Lump Sum & Death Benefit Allowance (LSDBA): Maximum tax‑free death benefit or payout is £1,073,100, unless protected by earlier schemes.

• Overseas Transfer Allowance (OTA): Limits the amount you can transfer overseas tax‑efficiently to £1,073,100.

  
  

Legacy Protection Schemes (Fixed & Individual Protections)

If you had valid LTA protection before abolition, these protections remain in effect:

• Fixed Protection 2016 or Individual Protection 2016 gives enhanced tax‑free relief—allowing higher lump sums than the standard £268,275, based on valuations on 5 April 2016 or earlier.

Providers must honour the protected amounts in perpetuity—even after LTA abolition.

How Much Can You Actually Contribute?

Understanding how much you can personally contribute to a pension each year helps you avoid excess tax charges and make the most of available tax relief.

Minimum Personal Contributions Without Earnings

• You can contribute up to £3,600 gross annually into a pension (i.e., £2,880 net plus 20% tax relief added) even if you have no earnings.

• This applies to non-working spouses, children, or anyone aged under 75 who is a UK resident.

Earnings-Based Contributions

• If you earn income, you can contribute up to 100% of your UK-relevant earnings, capped at the Annual Allowance (£60,000).

• “Relevant earnings” include salary, self-employment income, bonuses, commissions, redundancy pay (over £30,000), and taxable benefits in kind.

Employer Contributions

These do not count toward your individual earnings cap, but do count toward the £60,000 Annual Allowance.

Employer contributions are also usually exempt from National Insurance and benefit from corporation tax relief.

Inheritance Tax and Pension Pots (From April 2027)

In a major shift, the government confirmed that from April 2027, defined contribution pensions may become liable to Inheritance Tax (IHT) when passed to beneficiaries.

Current Position (2025)

• Pensions fall outside your estate for IHT purposes if you die before age 75.

• After age 75, beneficiaries are taxed on income they draw from the inherited pension, at their marginal tax rate.

Post-2027 Changes (Planned)

• The value of unused pensions may be counted within your estate for IHT calculation.

• Your beneficiaries may face a 40% tax bill if your estate exceeds the nil rate band (£325,000).

• Trust-based pension arrangements or earlier drawdowns may be used to mitigate exposure.

This makes it more critical than ever to plan pensions as part of a broader estate strategy.

Tax Planning Tips to Maximise Your Pension

Whether you're a basic-rate or additional-rate taxpayer, consider these tips to maximise your pension savings:

Use Salary Sacrifice

Agree with your employer to reduce your gross salary and have the difference paid into your pension. You save income tax and National Insurance—and so does your employer.

Maximise Basic Rate Bands

By making pension contributions, you can extend your basic-rate tax band and reduce exposure to 40% or 45% tax brackets.

Use Carry-Forward Efficiently

If you haven't used your full £60,000 allowance in previous years, catch up now and avoid future restrictions.

Consider Contributions for Non-Earners

Spouses or children can benefit from up to £3,600 gross annual pension contributions, even without an income—useful for family planning.

Split Pension Drawdowns

When you start withdrawing, take small amounts first. This ensures HMRC applies the correct tax code, preventing overpayment.

Professional Consolidation Advice

If you have multiple pension pots, consolidation could reduce fees and simplify management. Always seek financial advice to evaluate transfer charges and lost benefits.

FAQs About UK Pensions and Tax

1. What is the current tax-free lump sum limit?

£268,275, unless you have protection—this replaces the old 25% Lifetime Allowance rule.

2. Can I still get tax relief if I don’t work?

Yes. You can contribute up to £3,600 gross annually if you're a UK resident under 75.

3. What happens if I exceed the Annual Allowance?

You’ll pay a tax charge on the excess and must report it via your self-assessment.

4. Do employer contributions affect my personal allowance?

No—but they do count toward your £60,000 Annual Allowance.

5. Are pension pots taxed after death?

Yes—withdrawals are taxed if you die after age 75. From 2027, IHT may apply.

6. What are the new death and overseas transfer allowances?

Both capped at £1,073,100 for tax-free treatment.

7. How does pension tax relief work for higher-rate taxpayers?

They claim extra relief through a self-assessment tax return—up to 40% or 45%.

8. What is the Money Purchase Annual Allowance (MPAA)?

£10,000 limit if you've flexibly accessed pension income.

9. Can I combine unused allowances from previous years?

Yes—carry forward unused Annual Allowance from the past 3 tax years.

10. Does rental or investment income qualify for pension contributions?

No—only earned income like salary or self-employment counts.

11. How much can I contribute if I earn £100,000 a year?

Up to £60,000, unless the tapered Annual Allowance applies.

12. Will my pension count towards Inheritance Tax in 2027?

Yes—if unused at death, it may be counted in your estate for IHT.3,100These cap tax-free amounts that can be transferred or paid out as death benefits.

The Value of Informed Pension Planning

Pension rules have evolved significantly in the last two years—particularly with the abolition of the Lifetime Allowance and introduction of new lump sum thresholds. For higher earners, flexible access savers, or those nearing retirement, staying informed is more important than ever.

If you're uncertain about your pension strategy or want to make the most of your allowances, professional financial advice is strongly recommended.

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