Exceeding UK annual pension allowance

Question

Due to changing circumstances, I think I might exceed my UK pension allowance for the tax year 23/24. As I understand it, there is a tax charge for this at the marginal rate of Income tax. Is this tax just recovering the excess pension relief that my pension company claims on my behalf (thus I haven't lost anything directly I've just not been as tax-efficient as possible)? Or does this end up with me paying additional costs?

Notes:

• None of the higher-income rules apply
• I'm not eligible for the carry-forward benefits.

Answer 1

I think you're right, but they don't make it easy to find out. After chasing links on the HMRC website I eventually arrived at https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm056110, the "PTM056110 - Annual allowance: tax charge: rate of tax charge: general " page of the Pensions Tax Manual. The overview is:

The effect of the annual allowance charge is to reduce tax relief on any pension saving over the annual allowance.

The annual allowance charge is not at a fixed rate but will depend on how much taxable income the individual has and the amount of their pension saving in excess of the annual allowance.

To find out how much they will pay, the individual will need to work out the rate or rates of tax that would be charged if their excess pension savings were added to their taxable income.

My emphasis - it looks very much as if the charge you pay for exceeding annual allowance is simply the tax you would have had to pay if the excess contribution (above AA) had not been made but had been treated as taxable income. So, no additional 'penalty' charge.

Additionally it says

The amount of the tax charge will be worked out automatically if the individual is filing their Self Assessment tax return online.

Which I'm guessing might well apply to you.

Note that there's a whole load of complication when exceeding AA about who pays the charge (scheme or individual), so do be sure to look into that.

Answer 2

Normally with pensions you get exempted from income tax when you pay in, and then you pay tax when you withdraw from the pension, often at a lower marginal rate as you're retired by then so maybe you only pay 20% or 0% tax.

If you go over the annual allowance, then you end up being taxed on the way in to the pension. As you suggest this part does just reclaim the tax relief you and the pension scheme got. But you also get taxed when you withdraw your money.

Even worse, if you end up going over the lifetime allowance (abolished by the current government, but Labour, the likely winners of the next election, have said they'll bring it back), you'll end up paying an extra 25% penalty on top of the tax.

So overall it is worse than just not being tax efficient. If it's all your own money going in, and you can avoid it, try not to exceed the allowance. If it's an employer contribution or match funding that you would lose otherwise, then it might be worth it anyway.