Members of pension schemes in the UK enjoy tax relief on both their pension contributions and on cash lump sums taken at retirement. Pension income, however, is taxed as earned income under the PAYE system.
This preferential tax treatment is the government's way of incentivising individuals to save towards their retirement, but there are limits to their generosity. There are restrictions on the maximum tax-free benefit you can build up in any single year and the maximum tax-free benefits you can draw at retirement.
There are three different limits that apply:
1. Annual allowance - a restriction on the amount of benefits you can build up in a single year and still benefit from tax relief
2. Lifetime allowance – a restriction on the maximum amount of benefits you can earn up to retirement in a tax-beneficial way
3. Maximum tax-free cash – a limit to the amount of tax-free cash you can receive at retirement. This is expressed as a percentage of the value of the benefits you have earned with an absolute maximum
• 2015-16 Annual allowance guidance (.pdf)
The lifetime allowance limits the overall amount of tax-free retirement benefits you can build up. It's expressed as a capital value.For the 2015-16 tax year the limit is £1.25 million. This table will give you an indication of whether you may exceed the lifetime allowance.