Pension Annual Allowance Carry Forward explained

To use carry forward, there are certain conditions that need to be met. These include:

1. Contributions to your pensions must have used all of your annual allowance in the tax year you wish to use the carry forward rules.
2. You must have been a member of a UK-registered pension scheme* (this does not include the State Pension) in each of the tax years from which you wish to carry forward (you do not need to have paid any money into these schemes).
3. You must use any unused annual allowance from the earliest year first (you can only go back three years).
4. If you are subject to a tapered annual allowance, you need to measure any unused annual allowance against your reduced allowance for each given year (which may change depending on your adjusted income). You can find more information on the tapered annual allowance in our guide Tapered annual allowance.

*Broadly speaking, you'll be a member of a UK-registered scheme if you have a:

• defined contribution pension pot
• defined benefit pension
• pension credit membership where you have a share of your ex-partner’s pension
• guaranteed income for life from an annuity – but always ask your provider if you’re considered a member, as it depends how it was set up.

If you start to take more than the tax-free cash from your pension pot using the pension freedom options, this can trigger a lower annual allowance of £10,000 (current tax year) known as the Money Purchase Annual Allowance (MPAA).

This means you’ll normally only receive tax relief on pension contributions of up to 100% of your taxable earnings or £10,000, whichever is lower.

If you trigger the MPAA, you’ll no longer be able to use the carry forward option.

But, if you have an active defined benefit scheme (one that’s not closed to further contributions), there's an alternative annual allowance that may be used.

You can speak to your defined benefit scheme for further details on this.

As a basic guide, the main situations when you’ll trigger the MPAA are:

• If you take your entire pot as a lump sum or start to take lump sums from your pension pot as and when you want.
• If you put your pension pot money into a flexible retirement income product (pension drawdown) and start to take an income.
• if you purchase a fixed term annuity.
• If you buy an investment-linked or flexible annuity where your income could decrease.
• If you have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap.

The MPAA won’t normally be triggered if:

• You take a tax-free cash lump sum and buy a guaranteed income for life (a lifetime annuity) that either stays the same or increases each year.
• You take a tax-free cash lump sum and put your pension pot into flexible retirement income (pension drawdown) but don’t take any income from it.
• You withdraw, in full, one or more pots valued at less than £10,000 under the small pot lump sum rules.

The MPAA of £10,000 only applies to contributions to defined contribution pensions and not defined benefit pension schemes.

If you trigger the MPAA, your annual allowance will be reduced to £10,000 from the day after – and this applies to contributions to all of your defined contribution pension pots.

This means that any contributions made before the MPAA is triggered aren’t penalised. 

Carry forward might be particularly useful if you’re self-employed and your earnings change significantly each year, or if you’re looking to make large pension contributions.

If a particular tax year’s unused annual allowance isn’t fully used, it can only be carried forward for up to three years. After that, it’s lost. 

Remember, to receive tax relief your relevant earnings need to be the same or more than the total contributions to your pension scheme(s) in the tax year they are made.  

For example, if you want to make a contribution of £20,000 in a particular tax year, your earnings for Income Tax purposes for that tax year must be at least equal to £20,000.  

If you're considering making some large contributions that may be more than your earnings, then you might want to think about spreading the contributions over two (or more) tax years.

This will help maximise the amount of tax relief that you can get. It'll also help ensure you don't end up with an annual allowance tax charge that effectively claws back any tax relief you’ve received that you were not entitled to.

Plus, you’ll only get higher rate tax relief to the extent that you have paid it. This is another reason why you might want to spread large contributions over two (or more) tax years.

If you run your own business, the situation is a bit different.

One of the advantages of being an incorporated company is that you can decide whether any contributions into your pensions are to be made as a contribution from the company (as an employer) or as a personal contribution (as an employee).

If you want to make the contribution yourself with full tax relief applying, you will need enough earned income to cover the contribution, such as a salary – dividends don’t count.

For example, if you want to make a contribution of £20,000 in a particular tax year, your earnings for Income Tax purposes for that tax year must be at least equal to £20,000.  

If the money is to be paid into your pension as a company contribution, then any amount can be paid into the pension, without you needing to have corresponding earnings for Income Tax purposes as long as the contributions meet the ‘wholly and exclusively’ test.

As the contribution is coming from the company rather than you as an individual, it is therefore not liable for tax relief, but instead can be deducted as a business expense. In this way it is the company that benefits from a reduction against its corporation tax liabilities.

The contribution does count towards your annual allowance though, and so you may be able to carry forward unused allowances from previous tax years to allow a higher overall contribution in a particular tax year, without being subject to an annual allowance charge.  

One downside to this is that if the contribution is significant, it will reduce the amount of profit and the amount of dividend that can be paid for the accounting period.

To be an allowable deduction against trading profits, pension contributions have to be made wholly and exclusively for the purposes of the business.

In practice, contributions are normally allowed as a deduction against trading profits of the company for Corporation Tax purposes, subject to them being at a reasonable level for the individual concerned.

It’s important to speak to your tax/financial adviser to see whether it’s appropriate to make contributions on this basis.

Bill is self-employed and has been contributing £1,500 (net) a month into his personal pension for the last five years.

Over the last year, Bill has been working on a large contract and expects his profits for the 2024/25 tax year to be around £120,000.

He understands that he can reduce his tax bill and increase his retirement savings by contributing to his pension. He would like to pay in a further £60,000 during the 2024/25 tax year on top of his monthly contributions.

As Bill is already making monthly contributions to a personal pension, the first step for him is to work out the total of these once tax relief has been applied.

To calculate this, he needs to take the £1,500 he's contributing and divide it by 0.8 (1-20% - the basic rate of Income Tax).

His contributions therefore work out to be £1,875 a month or £22,500 for the year.

Bill wants to pay an extra £60,000 into his pension. After applying basic rate tax relief, as above, the total (gross) contribution works out to be £75,000. 

In 2024/25, Bill's annual allowance is £60,000. After deducting his monthly contributions of £22,500 he'll have £37,500 available to use this tax year.

Bill also has unused annual allowances over each of the last three years, so he elects to use carry forward and use his unused allowance of £17,500 from 2021/22, £17,500 from 2022/23, and £2,500 from 2023/24.

By using carry forward, Bill can get tax relief on his total gross contributions of £97,500 in 2024/25 (£22,500 monthly contributions + £75,000 additional contribution).

If he has another good year next year, he might want to make another additional contribution to his pension, and has unused annual allowance of £35,000 available to carry forward from the 2023/24 tax year.