For tax purposes, the annual allowance is a cap or limit on the total amount of contributions that can be paid to defined contribution pension schemes and the overall amount of compensation that can be built up in defined benefit pension schemes each year.
The government spends billions of pounds each year on pension tax relief, so there is a limit to how much you can save each year and earn relief. This limit is known as the ‘annual allowance .’ It is currently set at £40,000 in the 2021-22 tax year, or 100% of your income if you earn less than £40,000.
The annual Pension Allowance applies to all of the schemes to which you are a member; there is no ‘per scheme’ limit and involves all contributions paid by you, your employer, or anyone else on your behalf.
Pension contributions accumulate a pension pot through your assistance and the contributions of your employer (if applicable), as well as investment returns and tax breaks.
As a member of the scheme, your contributions are usually deducted from your salary before it is taxed through an employer.
The current pension contribution limit is 100% of your income, with a cap of £40,000. It includes both your contributions and those made by your employer.
If you contribute more than this, you will not receive tax relief on any sum over the contribution limit and will be required to pay tax on any amount over the contribution limit. It is known as a ‘annual allowance charge .’ It is transferred to the rest of your taxable income for the year when your tax liability is calculated.
The tax charge is calculated by adding the excess pension savings to the ‘reduced net income’ and then summing the tax due on the excessive amount. Reduced net income is the amount of tax that an individual pays for a tax year (taxable income less personal allowances).
Pension annual allowance calculation
If a scheme administrator pays some or all of a charge under the ‘scheme pays’ provision, the tax charge includes the scheme’s Accounting for Tax Return. The member must also include information about the cost on their self-assessment form, including any amount paid by the system. The member will bear any outstanding charges.