Loopholes to get around the annual pensions limit

If you've used up your annual allowance there are still many ways to save efficiently for your later years

October 11, 2023

You may be able to carry forward unused pension allowances from the previous three tax years
Isas are a very tax-efficient way to save for, and take income in, retirement
High earners could consider venture capital trusts (VCTs)

The pensions annual allowance rose from £40,000 to £60,000 at the start of the current tax year, but this increased threshold may be exceeded by some high earners and the tapered annual allowance (see box) may have an impact, too. Fortunately, there are a series of options open to even these savers.

For instance, your employer might be able to make a tax-efficient contribution to your pension even if that takes the total value of contributions above the value of your earnings in the relevant tax year. HM Revenue & Customs has to deem this as being wholly and exclusively for the purpose of business, so generally the contribution should be of a reasonable level in relation to your work for the company and proportionate to the value you add to it. This can be particularly useful if you own your own business, are self-employed or if your earnings and pension contributions tend to fluctuate.

Separately, you may be able to carry forward unused pension allowances from the previous three tax years. To do this, you must earn at least the amount you wish to contribute in the same tax year – unless your employer is making the contribution. You also need to have been a member of a UK-registered pension scheme in each of the tax years from which you wish to carry forward unused allowances, although you don't need to have made contributions. This means that a retirement saver could contribute as much as £180,000 into a pension in 2023-24 if they have the necessary allowances and income. But if your pension annual allowance was also tapered in previous tax years, you can only carry forward the amount you didn’t use.

Carry forward could be particularly useful if, for example, you earn more than £60,000 in the 2023-24 tax year and want to maximise pension contributions; if you have an irregular earnings pattern and want to make a large pension contribution in a good year; or if you have a tapered annual allowance. For example, if you earned, say, nothing in the last year but £100,000 in 2023-24, you could contribute up to £100,000 to a pension using the £40,000 annual allowance permitted in 2022-23 and the £60,000 annual allowance allowed for the current tax year.

Petronella West, chief executive officer of Investment Quorum, adds that using carry forward is particularly relevant if you are a higher or additional rate taxpayer and so receive government relief of 40 or 45 per cent, respectively, on pension contributions.

The government has a calculator to help you work out if you can use carry forward at www.tax.service.gov.uk/pension-annual-allowance-calculator. However, “using carry forward is complicated and carries technical subtleties so is primarily [for] highest earners, those closest to retirement who are seeking to maximise their pension savings or the self-employed who may see peaks and troughs in their annual income,” cautions Alistair McQueen, head of savings and retirement at Aviva.

Another consideration is that you cannot access private pensions until age 55, or age 57 as of 2028. “If you are looking for earlier or more flexible access to your money, optimising your pension savings may not be right for you,” adds McQueen.

So using your individual savings account (Isa) allowance before pensions carry forward might work better for your plans, although you would miss out on government tax relief – especially if you are a higher or additional rate taxpayer.

On top of this, although you can take up to 25 per cent of the value of your pensions tax-free, withdrawals above this level are taxed at your marginal rate – so it is sensible to diversify beyond pensions when saving for retirement.

How much can you save into pensions each year?

The maximum amount you can put into your pension each year while still receiving tax relief is £60,000 or the value of your qualifying earnings for the period – whichever is less. If you do exceed your allowance, the excess pension contribution is, in effect, subject to income tax at your marginal rate.

If your income comes from, for example, dividends and buy-to-let income rather than a salary, the amount falls to £3,600 a year – £2,880 from you and the remainder from tax relief.

If your threshold income (income less pension contributions and other specific deductions) is over £200,000 and adjusted income (income less specific deductions but including pension contributions made by you and your employer) over £260,000, your pensions annual allowance is tapered between £260,000 and £360,000, so that those earning more than the latter amount only have a pensions annual allowance of £10,000. Those with adjusted incomes have an annual allowance of between £60,000 and £10,000.

If you’ve started to withdraw money other than the tax-free sum from a defined-contribution pension, you are likely to have triggered the money purchase annual allowance. This restricts the amount you can contribute to £10,000 a year.

Non-pension options

After using up your pensions allowance, the next key way to save is via Isas, into which you can put up to £20,000 a year. As with pensions, assets within them grow free of capital gains and income tax. Contributions don’t receive tax relief at your marginal rate but withdrawals are tax-free – unlike withdrawals from the taxable portion of pensions. West notes that Isas "have a much bigger role for basic rate taxpayers", because this group doesn't receive 40 or 45 per cent tax relief on pension contributions yet may still pay 20 per cent on some withdrawals.

So if you are a basic rate taxpayer you should consider using up annual Isa allowances before using pensions carry forward unless, for example, your employer matches the extra pension contributions made using carry forward. As you cannot carry the annual Isa allowance forward, you should try to use it every year.

Lifetime Isas (Lisas) can be used to build up funds for retirement if you do not use them to buy a first home. You can contribute up to £4,000 a year to Lisas and the government adds a 25 per cent bonus of up to £1,000 a year. For basic rate taxpayers, the government bonus has the same impact as the 20 per cent tax relief on pension contributions, due to how they are calculated. Withdrawals from Lisas after age 60 are tax-free, whereas some pension withdrawals may be taxed.

However, you have to be between ages 18 and 40 to open a Lisa, although you can make contributions until age 50. And you cannot withdraw money from a Lisa before age 60 unless it is to buy a first home or because you are terminally ill with less than 12 months to live. If you withdraw other than for those reasons, you'll pay a charge of 25 per cent of the withdrawal value.

If you've used up your annual pension and Isa allowances you could build up investments in general investment accounts. These have no tax benefits but you can offset income and withdrawals from them against the annual capital gains, dividend, personal and personal savings allowances.

When you have used up your pensions, Isa and tax allowances, consider transferring assets to your spouse so that you both make full use of them each year.

High earners, meanwhile, could consider venture capital trusts (VCTs). These offer income tax relief of 30 per cent if you hold them for at least five years, and pay tax-free dividends that could form a part of a retirement income. However, they invest in early-stage companies and are high-risk, so only use them if you have a substantial taxable income and after exhausting all other options.

Pension lifetime allowance limits aside, spreading retirement savings across various accounts enables you to make use of the various tax allowances and draw all, or at least a good portion of, your retirement income-tax-free.