Most people won't pay any tax on their pension until they have retired, at which point regular income tax is applied. The government have, however, set allowances for the amount which your pension can increase by in a year before you must pay tax as you earn it. Please follow the link below for more information on these allowances and their tax consequences.
The Government has placed a restriction on the amount of pension individuals may earn each year before they suffer additional income tax liability. For the purpose of calculating Annual Allowance, each year is referred to as a Pension Input Period (PIP). All schemes' PIPs have been aligned to tax years, i.e. from 6th April to 5th April. For each year or PIP, the maximum growth is restricted to a capital monetary value of £60,000. This value is calculated by multiplying the increase in pension over the twelve month period by a factor of 16 then adding the increase in any lump sum entitlement.
Value of benefits as at 5th April 2023
Pension of £8,000 plus lump sum of £20,000
Monetary value of £128,000 (£8,000 X 16) plus £20,000 = £148,000
Value of benefits as at 5th April 2024
Pension of £9,000 plus lump sum of £23,000
Monetary value of £144,000 (£9,000 X 16) plus £23,000 = £167,000
Consumer Prices Index at 10.1%
Annual allowance figure
Value as at 5th April 2024 = £167,000
Revalued 5th April 2023 value (148,000 x 10.1%) = £162,948
Annual Allowance figure = £4,052
Any Additional Voluntary Contributions, buying of additional service or additional pension must also be included towards this Allowance.
If your Annual Allowance exceeds the limit in any year then you are able to bring forward any unused allowance from the previous 3 years. If this still results in an excess amount then this excess amount must be declared on your annual self assessment income tax return and is added to your other taxable income and taxed at your marginal income tax rate.
Where the amount of tax payable exceeds £2000 an individual has the option to request the LGPS to pay the cost and have a subsequent reduction applied to their pension benefits.
HM Revenue and Customs have an online calculator which allows you to check if you have an annual allowance tax charge on your pension savings.