The importance of planning your pension contributions
Background
The concept behind investing in a pension scheme is sound. You get tax privileges as you put money in and whilst you invest. In addition, you only pay tax when you take money out and even then there is the tax free lump sum to be taken.
By adequately funding a pension scheme, it becomes possible to consider inheritance tax planning as your post-retirement standard of living will have been secured.
Annual allowance
The annual allowance is a limit on the total amount that can be paid into your pension scheme(s) each year and still receive tax relief. It’s capped at the maximum of your earnings or, if less, the amount of £40,000. The tax relief will be given at your marginal tax rate.
The annual allowance applies all of the contributions that you or your employer pays. It is not per pension scheme. If you exceed your annual allowance, you won’t get tax relief on any contributions that exceed the limit and you will be subject to an annual allowance charge.
It is however possible to carry forward unused relief for up to three years. In 2018/19, any unused relief from the three previous years (£40,000 for each of 2015/16, 2016/17 and 2017/18) may be utilised with the current year allowance against your income in 2018/19.
However, 2018/19 was the last chance to use any un-utilised pension allowance for the 2015/16 tax year based on the full carry forward annual allowance of £40,000. From 6 April 2019, the earliest carry forward amount will be subject to the restriction on pension tax relief for higher earners where the tax relief could be as little as £10,000 for the tax year (see below).
Restriction on pension tax relief for higher earners
With effect from 2016/17, the government introduced a taper to the annual allowance for those with adjusted and annual incomes, including their own and employer’s pension contributions, over £150,000. For every £2 of adjusted income over £150,000, an individual’s annual allowance will be reduced by £1, down to a minimum of £10,000 for those with pensionable earnings of more than £210,000.
There is however a threshold before the tapering annual allowance applies. If your net income is £110,000 or less, tapering of your pension contributions will not apply, subject to the targeted anti avoidance rules.
Lifetime allowance
The lifetime allowance is the limit in the amount of pension benefit that can be drawn from a scheme / schemes without triggering an extra tax charge.
The lifetime allowance increased to £1,055,000 in 2019/20. Certain taxpayers who have already funded their pension plans on the basis of the previous lifetime limits had the opportunity to apply for fixed protection to fix their lifetime allowance to the previous limit.
Applying for fixed protection means you will no longer be able to make any further contributions to your pension plans. If that is so, negotiation with your employer may be necessary to obtain a salary replacement in lieu of pension contributions.
Taking benefits from your pension scheme
Individuals can take income from their pension fund with no restrictions as to the amount withdrawn or the timings of those withdrawals. Taken to the extreme, you could take out the entirety of your pension scheme albeit at the expense of income tax at your marginal tax rate on the funds withdrawn in excess of the tax free lump sum.
The 25% tax free lump sum is well known, but under the new rules, you can continue to take the lump sum as before when first drawing benefits from your pension fund, or alternatively you can take 25% of every payment tax free, with the remainder being taxed at your marginal tax rate.
Payments to widows/ widowers
Certain lump sum payments from a pension fund can be made advantageously. The payment has to be made within two years of the individual’s death and be within the lifetime allowance. That means that where the deceased was aged 75 years or over, the beneficiary of their pension scheme will pay tax at their marginal rate of income tax as they draw money from the pension fund. If the deceased was under 75 years of age, no income tax is payable on the funds drawn by the beneficiary of their pension fund.
As an alternative, the lump sum payment can be made to a discretionary trust, sometimes referred to as a spousal bypass trust, to maintain flexibility within a family as to who benefits from the deceased’s pension fund.
Do you need help with your pension arrangements?
If you think that you may be getting close to your annual allowance or lifetime allowance, or may have exceeded it, we recommend you take professional advice. You can contact a member of our team today on 020 3195 1300.
