Pension tax relief: The annual allowance and lifetime allowance

This briefing gives an overview of the limits to pension income tax relief in the UK. For a general overview of pensions taxation, see the Library briefing Pensions Tax.

How are private pensions taxed in the UK?

In the UK, private pensions use an “exempt, exempt, taxed” (EET) model for income tax:

• Exempt: People do not pay income tax on pension contributions, although there are limits on these contributions.
• Exempt: People do not pay income tax if their pension investments increase in value.
• Taxed: Withdrawals from pensions incur income tax like other income. However, people can withdraw up to 25% of their pension as a tax-free lump sum.

What are the limits to pension income tax relief?

There are limits on the amount of pensions income tax relief someone can receive.

Limits to tax-free contributions

An annual allowance limits the amount someone can pay into pension schemes each year before they must pay income tax. The limit is £60,000 in 2024/25.

A person cannot usually receive tax relief on pension contributions worth more than 100% of their annual earnings. However, people can still contribute £3,600 a year into a pension with tax relief even if they earn less than this.

The annual allowance is tapered (reduced) for higher earners. It is reduced by £1 for every £2 someone earns over £260,000 (including pension contributions). Tapering stops when the annual allowance reaches £10,000.

In defined contribution pension schemes people build up a pot of money that can be used for retirement. In certain circumstances if someone withdraws money from a defined contribution scheme then the amount that they can contribute to these schemes in future – and still receive tax relief – reduces permanently. The lower allowance, known as the money purchase annual allowance, is set at £10,000 a year.

Abolition of the lifetime allowance

There was a limit on the amount people can build up in pension schemes over their lifetime and still receive tax relief.

At the Spring Budget 2023, the government announced that it would abolish the lifetime allowance. It started this process by removing the tax charge for exceeding the lifetime allowance from 6 April 2023 and abolished the lifetime allowance fully in the Finance Act 2024 from 6 April 2024.

What are the options for reform?

The Library briefing Reform of pension tax relief discusses in more detail the different approaches that may be taken to taxing pensions, and reforms that have been made to the UK system.