Triggering Annual Allowance tax charge

The Annual Allowance (AA) is increasing to £60,000 from 6 April 2023.

An annual allowance tax charge can be triggered when an increase in pension benefits occurs. This can be based on an increase in pensionable pay and purchasing additional pension rights.

Purchasing a large amount of additional pension over a short period, or by lump sum, can result in a sudden spike in your pension entitlement.  This can trigger an Annual Allowance (AA) tax charge.

Reducing an AA tax charge

You may have unused allowances from a previous year that would help offset any tax charge or reduce it to nil. An annual allowance excess which cannot be offset by previous years unused allowances will result in a tax charge even if your normal income is below the level required to pay income tax.

Purchasing a lesser amount of additional pension, or spreading payments over a longer period, may help reduce the likelihood of a charge.

Examples of triggering an AA tax charge

You purchase £3,000 additional pension by lump sum. This will increase your pension benefits in the year of the purchase by £48,000 (£3,000 x factor of 16). This does not take into account the normal contributions paid to the scheme for that year. It  exceeds the limit for the year. You will have an annual allowance excess. You will have to rely on previous years unused allowances to reduce the liability for tax.

You purchase £3,000 additional pension. You have monthly deductions over an 8 year period. This will increase your benefits by one eighth of the £3,000 each year.  That is £375 each year. This increases your benefits each year (excluding any other contributions) by £6,000 (£375.00 x factor of 16). This is below the annual allowance limit and should not incur a tax charge.

Tax relief

Payments made through your payroll, whether by lump sum or regular payments, will attract tax relief at source in line with your personal tax code.

Payments made direct to the scheme via a cheque may not entitle you to tax relief. You should seek advice from HMRC before making a payment. Visit the HMRC website