Pension Annual Allowance Planning

As I have mentioned in articles before, contributing to a pension can be a great way to help build wealth, particularly due to the tax relief that is available to increase the contribution.

For most people, the amount that they can contribute to a pension fund each year will be dictated by what they can afford, whether as a percentage of their earnings, or based upon any cash savings that they may wish to contribute to a pension fund.

For some, it will be restricted to the pension annual allowance of £40,000 (gross). Ordinarily, this is the maximum that can be contributed to a pension fund in one tax year on which tax relief can be obtained. Any contributions in excess of this amount could potentially result in a tax liability.

Furthermore, as soon as your income, inclusive of employer contributions exceeds £240,000 (£150,000 before 6 April 2020), your pension annual allowance starts to get reduced by £1 for every £2 of income above it. This is known as the tapering of the annual allowance and the taper is restricted to £36,000 (£30,000 previously).

Therefore, by the time your income, including employer contributions hits £312,000 (£210,000 previously) or more, your pension annual allowance is restricted to just £4,000 (£10,000 previously) that you can contribute to a pension each year and receive tax relief. This includes employer contributions. If you exceed this, you may have to pay a tax charge.

Any unused pension annual allowances from the previous 3 tax years can be used, as long as a pension scheme was in place. If you have income of above £312,000 in one year due to a one off bonus payment and your tapered annual allowance was just £4,000 then it might be possible to make use of any of the unused £40,000 allowances from the previous 3 tax years (assuming income and employer contributions was less than £240,000 and £150,000 thresholds in each of those earlier years). In this case, a maximum of £124,000 (gross) could be contributed to a pension fund if there had been no contributions in the earlier year and there was a pension fund in place.

This kind of planning could save tax of 45% (£55,800) based on this example, despite having income of £312,000.

If you or any of your family, friends and colleagues have income above £100,000, or any unused pension annual allowances, please give me a call to see whether you or they could benefit from some significant tax savings as a result of this kind of planning.

Great care needs to be taken if you are in some kind of defined benefit pension scheme where you are guaranteed a pension in retirement based upon your career earnings. Please get in touch with our Financial Planning Team if this is the case.