Pension contributions are taken from earnings automatically, so if you had unexpected extra income during the year (bonus, overtime), contributions would increase.

What would happen if too much had then been put into a SIPP? I assume the employer’s pension scheme would take precedence, and the excess in the SIPP then not given a tax credit. But that tax credit could have made gains by the end of the tax year, when you know exactly what your earnings were, and what pension contributions were made. Who calculates how much is discounted? Seems quite complicated.

David 

Rachel Vahey, AJ Bell Head of Public Policy, says:

How much you can save tax-efficiently into a pension is a complicated area.

As a reminder, there are two different limits. The first is on the maximum contributions an individual may make to their pension and claim tax relief. This is capped at the higher of £3,600 or 100% of the pension saver’s relevant UK earnings, including the tax relief. (Very broadly, relevant earnings are earned income or self-employment income, including bonuses, but not including investment income, such as dividend income.)

The second limit is the annual allowance which covers any personal contributions, employer contributions and tax relief.  The standard annual allowance is £60,000 but it could be lower if someone is a very high earner or has previously ‘flexibly accessed’ their benefits, usually by taking taxed withdrawals from their flexi-access income drawdown plan. Doing so would trigger the money purchase annual allowance (MPAA) which is £10,000.

WHAT ABOUT IF YOU DON’T HAVE ANY EARNINGS?

Even if someone doesn’t have any earnings they can still contribute up to £2,880 a year and receive 20% tax relief, making a total contribution of £3,600.Many people have a workplace pension scheme that they and their employer pay into. They may also save an additional amount to a SIPP they personally set up.

As workplace pension contributions are usually set as a percentage of earnings, the actual amount saved each tax year could fluctuate depending on whether additional earnings such as bonus and overtime are counted in the definition of earnings when working out the workplace contributions. This will depend on the employer’s pension arrangements, but they often are.

Fluctuating contributions mean it can be harder to keep track of how much has been paid into pensions in a tax year.

If the annual allowance is exceeded, then it may be possible to carry forward any unused annual allowance from the previous three tax years to count against contributions paid in. (This doesn’t apply if the MPAA has been triggered.) If there is no unused annual allowance available, then tax will have to be paid on any contributions over the allowance. This is called the annual allowance tax charge.

It’s not possible to ask the pension scheme to refund the excess over the annual allowance.

PAYING ANY TAX CHARGE

The individual can pay the tax charge from their own money, or, in certain circumstances the pension provider may be able to pay the charge and, if so, will reduce the value of the individual’s pension.  The pension scheme that pays the charge doesn’t have to be the one that receives the fatal contribution that tipped someone over the annual allowance – it could be any pension scheme the individual has paid into, as long as the scheme agrees to make the payment. (Sometimes the scheme has to pay the tax charge if asked.)

Either way, the individual has to complete a self-assessment tax return.

If the individual has paid in more than 100% of their relevant earnings, then they must let their pension scheme know and provide evidence of earnings.

There isn’t a tax charge, but any tax relief received on the excess contribution has to be refunded to HMRC. It will be up to the pension scheme whether the net contribution goes back to the member or remains in the pension scheme. Refunds can only be made once the tax year has ended.

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