Can you utilise your pensions annual allowance for a tax year where you have no earnings?

Most people are aware of the annual allowance which exists for pension contributions. In years up to 2022/23 the annual allowance was £40,000. From 2023/24 onwards the allowance is £60,000.

The issue

Individuals can contribute up to this amount into their pension with full tax relief provided they have sufficient relevant UK earnings. By way of example, if an individual wants to contribute £60,000 then they will, in most cases, pay £48,000 into the pension, which the Government will then top-up by a further £12,000 (being the basic rate 20% tax relief). Higher and additional rate tax relief is then claimed through the individual’s self-assessment tax return.

It is the relevant UK earnings condition which can often act as the limiting factor. The main types of relevant UK earnings are income from employment, self-employment and (until 5 April 2025) furnished holiday lettings. The issue can particularly affect sole traders and other individuals who do not have the benefit of an employer to make contributions on their behalf.

What can be done if there are insufficient relevant UK earnings in a particular tax year?

Pension rules

The first point to note is that all individuals are entitled to a "basic amount" of £3,600 on which pension tax relief can be obtained, regardless of their level of relevant UK earnings. However, this clearly only offers a small fraction of the maximum allowance.

Fortunately, this is where the pension rules provide extra flexibility. Provided an individual has a pension in a tax year they can carry forward any unused annual allowances by up to a further three tax years. Furthermore, and contrary to what you might think, the amount of the allowance is not limited by the relevant UK earnings in the earlier tax year, although you must have sufficient relevant UK earnings in the year of the contribution.

Example

Jeremy operates as a consultant in the advertising industry. He has the following income:

• Tax year 2021/22 total income £100,000, consisting of sole-trader income £0; dividend income £100,000

• Tax year 2022/23 total income £110,000, consisting of sole-trader income £10,000; dividend income £100,000

• Tax year 2023/24 total income £140,000, consisting of sole-trade income £40,000; dividend income £100,000

• Tax year 2024/25 total income £300,000, consisting of sole-trade income £200,000; dividend income £100,000

He has a pension in all years but did not make any contributions during the first three years, as his business was only just taking off. Consequently, in 2024/25 he has brought forward allowances of £140,000 and a potential current year allowance of £60,000 (but see below).

Because he has relevant UK earnings in 2024/25 of £200,000, he should be able to utilise all his brought forward allowances, despite only having £50,000 of relevant UK earnings in the earlier years.

High earner rules

Note that annual allowances can also be affected by “high earner” rules. Under current rules, an individual who has “threshold income” of more than £200,000 and “adjusted income” of more than £260,000 will have their annual allowance tapered by £1 for every £2 by which the adjusted income limit is exceeded (but not to below £10,000).

Threshold income is broadly all taxable income excluding pension contributions, and adjusted income is broadly all taxable income including pension contributions.

In Jeremy’s case, he gets the full annual allowance in the first three years as his income was well below the limits. However, in 2024/25 his threshold and adjusted income is £300,000. Consequently, his annual allowance would ordinarily be tapered down to £10,000.

This is where making the large pension contribution comes in to its own...

If he makes the maximum contribution of £200,000 – by contributing £160,000 and then getting the scheme administrator to claim the extra 20% from the Government – his threshold income will be reduced to £100,000 and the high earner rules will not apply!

Hamilton Rose's view

This is a useful reminder that the annual allowance rules do not always operate in the way that one would think. In the above example, Jeremy has benefited from both being able to use full brought forward allowances, and avoid a restriction to his current year annual allowance through smart use of the rules.