Investment - Articles - Tax charges on pension savers surge 22%

David Little, Partner in Financial Planning at wealth management firm Evelyn Partners, comments: ‘These are quite striking increases of 22 per cent in the number of individuals reporting AA breaches and 33 per cent in the total value of contributions above the AA. The pensions annual allowance is the maximum amount of tax-free money you can contribute to your pensions each tax year, and the full AA is currently £60,000, as it was in both these tax years.

'What is slightly surprising about the figures is that the AA was raised from £40,000 to £60,000 by then Chancellor Jeremy Hunt in April 2023 following his Spring Budget. That, you might have expected, would lead to a fall in breaches in the subsequent years as people had more leeway to make large annual pension contributions than they had enjoyed for nearly 10 years.

'It's not easy to pin down the cause, but a very plausible one is that more high earners were being surprised by the tapered annual allowance. Plausible because this was a period of elevated inflation when high earners could easily have lost track of the impact on pension contributions of increasing salaries and bonuses. Also many AA breaches occur within defined benefit schemes where it is harder for employees to keep track of how their pension is tested against the AA, and generous public sector pay deals during this period could have contributed.

‘However, there may be other factors at play than just the tapered annual allowance. Both years being compared had the £60,000 standard allowance, and the increase could be due to earners exceeding the full AA by mistake as their earnings rose or as they sacrificed large bonuses into their pension. Increased employer contributions and unexpectedly high pension growth within defined-benefit schemes can also drive AA breaches.

'But the taper remains a particular trap because the headline £60,000 allowance can give higher earners a false sense of security. Where threshold income exceeds £200,000 and adjusted income exceeds £260,000, the allowance is reduced by £1 for every £2 of additional adjusted income, potentially falling to just £10,000.

'Adjusted income includes employer pension funding, so somebody may be caught even where their personal contributions appear relatively modest. Bonuses paid at the end of the tax year, variable earnings and contributions across several schemes make the final position difficult to predict until late in the tax year, by which time it’s very difficult to unwind pension contributions made during the tax year. Also HMRC doesn’t monitor these breaches in real time, it relies on self-reporting, which means some savers don’t realise for two or three years that they’ve been over-contributing, and then are faced with a big tax back-charge.

'The key is to plan before the tax year has ended rather than waiting for a pension statement or tax return to reveal the problem. Savers should obtain up-to-date pension input figures from every scheme, estimate their total income including bonuses and benefits, and check whether unused allowance can be carried forward from the previous three tax years. Defined-benefit members need particular care because the amount tested is the increase in the value of their promised pension, not simply what they have personally paid in.

'Where a charge on an AA breach is unavoidable, savers should establish whether Scheme Pays is available to allow the charge to be paid from their pension scheme, but they should not automatically stop pension saving simply to avoid a tax charge. Giving up valuable employer contributions, tax free growth inside the pension fund or defined-benefit accrual could leave them materially worse off in the long run. Sometimes paying the tax charge is the best option.

'What we are seeing here is evidence that pension taxation remains too complex for most people and even financially savvy earners can get caught out. It’s striking how many high earners are completely unaware that their pension allowances are tapered until it’s too late.'