This can broadly be covered in a couple of sentences. Firstly, contributions paid by individuals are restricted to the lower of a client’s earnings and their available annual allowance (including available carry forward from the previous three tax years).
Secondly, overall contributions, taking into consideration employer contributions and defined benefit accrual, are not limited by the individual’s earnings, but are restricted to available annual allowance, again allowing for any carry forward.
Minor complications exist for individuals with no or low earnings and for individuals aged 75 or over. The former can still contribute up to £3,600 (gross). The latter cannot get tax relief on personal contributions, but still have an annual allowance, and this may create planning opportunities as greater numbers of older individuals continue working.
One area of confusion about which queries arise from advisers and clients is whether the requirement for earnings falls in the tax year in which a contribution is paid, or the tax year from which the annual allowance is used up.
This question is only really relevant where carry forward is being used up. The answer is simply that it is the earnings in the tax year of payment which are of relevance, not the tax year from which annual allowance is being carried forward.
In other words, you can not justify a contribution this tax year based on earnings from previous tax years.
For example, if someone has earnings of £100,000 in 2018 to 2019 but no earnings in earlier tax years, they can make a personal contribution of up to £100,000 (£80,000 net) in the current tax year – assuming carry forward is available.
Conversely an individual with earnings of £40,000 in each of the last four tax years would only be able to make a personal contribution of £40,000 (£32,000 net) in the current tax year.
I have touched on carry forward a couple of times now. So what is this and how does it affect the annual allowance?
Placing it in a historic context, the current annual allowance of £40,000 is significantly lower than the peak allowance of £255,000 in 2011 to 2012.
While the scope to make six-figure pension savings year on year has disappeared, the introduction of ‘carry forward’ in 2012 allowed individuals to use unused annual allowance from the three previous tax years.
This is useful if individuals without significant savings in most years happen to have a tax year in which they have a big jump in accrual either by accident or by design.