Pension annual allowance

Your pension savings can only grow by so much in a tax year before you pay a tax charge, and that limit is the annual allowance. In public sector schemes like the NHS Pension Scheme and the Teachers’ Pension Scheme, growth is measured as the increase in the value of your pension promise, whatever you pay in. Most staff are nowhere near the limit. It mainly affects senior people, such as NHS consultants, band 8 and 9 managers, headteachers and senior civil servants, especially in a year with a large pay rise or promotion.

How growth is measured in a defined benefit scheme

The NHS, teachers’, Civil Service and local government schemes give you no pot. They give you a promise of a yearly pension. HMRC values that promise by taking your pension at the start and end of the pension input period (which matches the tax year), multiplying each by a fixed factor, and adding a value for any lump sum. The difference, after allowing for inflation, is your pension input amount for the year.

Two things push it up. Ordinary build-up is one: each year in a career average scheme adds a slice of pension. A jump in pay is the other, and it matters most for anyone with service in a final salary section, because a pay rise lifts the value of every year already earned there. A promotion from deputy to headship, or a move into a senior band, can therefore produce a large pension input amount in one year even though your contributions barely changed.

The standard annual allowance is £60,000 a year, the level set from 6 April 2023. If you have flexibly accessed a defined contribution pension, the money purchase annual allowance of £10,000 applies to defined contribution savings instead.

Who is likely to be affected

For most staff the yearly growth in pension is far below the allowance. Someone on a band 5 or 6 salary, a main scale teacher or an EO in the Civil Service has very little chance of reaching it through scheme build-up alone.

The risk rises with pay. Medical consultants, senior managers in NHS bands 8b, 8c and 8d, staff on band 9, school leaders near the top of the leadership pay range, senior police officers and senior civil servants tend to come close. Buying added pension or paying into an AVC uses up allowance too.

A tapered annual allowance applies to people with very high total income, but only if your threshold income is over £200,000 and your adjusted income is over £260,000. For every £2 of adjusted income above £260,000 the allowance falls by £1, down to a minimum of £10,000. Adjusted income includes the value of pension growth, so the taper can catch people whose salary alone looks below the threshold. HMRC’s guidance sets out how to work out both measures.

Carry forward

If you exceed the allowance in one year, you can use unused allowance from the previous three tax years, as long as you were a member of a registered pension scheme in those years. You use the current year’s allowance first, then the earliest year available.

That is why many people with a one-off spike never pay a charge. A senior manager promoted from band 8a to band 8c, say, might have a large pension input amount that year but plenty of unused allowance from earlier years at lower pay. Carry forward has to be worked out each time, and the figures for past years come from your pension savings statements.

How the charge is worked out

Any excess over your available allowance is added to your income and taxed at your marginal rate. In England, Wales and Northern Ireland, that is 20 per cent, 40 per cent or 45 per cent depending on where the excess falls in your income tax bands. In Scotland the Scottish rates apply, which go up to 42 per cent at the higher rate, 45 per cent at the advanced rate and 48 per cent at the top rate.

The charge claws back the tax relief you received on pension savings above the limit, because contributions to public sector schemes are taken from pay before tax. Pay that falls in the band where the personal allowance is tapered away, between £100,000 and £125,140, is taxed at an effective rate higher than the headline rate, and the £100,000 tax trap guide explains that interaction.

Telling HMRC and paying

Your scheme sends you a pension savings statement if your pension input amount in that scheme goes over the standard allowance, and you can ask for one at any time. If you think you are over, you report the charge through Self Assessment. The online deadline is 31 January after the end of the tax year. The Self Assessment guide explains registering if you do not usually file.

You can pay the charge yourself, or ask the scheme to pay it under Scheme Pays. With Scheme Pays the scheme settles the bill with HMRC and reduces your pension at retirement to cover it, with interest built in. Schemes must offer this when your charge is over £2,000 and your pension input amount in that scheme alone is over the £60,000 standard allowance. Many public sector schemes also offer it voluntarily below those limits. For mandatory Scheme Pays the election normally has to reach the scheme by 31 July in the year after the following tax year, so check the exact date with your scheme.

Getting help

Annual allowance calculations for public sector members are fiddly, particularly if you have both final salary and career average service, or if the McCloud remedy has moved past service between schemes. The remedy also led schemes to reissue some pension savings statements, and HMRC has arrangements to adjust charges paid or owed for those years.

Your scheme administrator can provide statements and explain the figures. HMRC’s annual allowance calculator helps you check carry forward. Professional bodies such as the BMA and some unions publish guidance for their members, and many senior staff use an accountant or a regulated financial adviser to check the numbers and decide what to do about future build-up.