Using your pension annual allowance

Contributing to a pension can be a great way to help build wealth, particularly due to the tax relief that is available.

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. 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 actually result in a tax liability.

Furthermore, as soon as your income, inclusive of employer contributions exceeds £150,000, 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 £30,000. Therefore, by the time your income, including any pension contributions your employer makes, hits £210,000 or more, your pension annual allowance is restricted to £10,000, and this will be the maximum that you can contribute to a pension each year and receive tax relief. This includes employer contributions.

Any unused pension annual allowances from previous years can be used, as long as a pension scheme was in place. If you had income of above £210,000 in one year due to a one off bonus payment and, your tapered annual allowance was just £10,000, then it would be possible to make use of any of the unused £40,000 allowances from the previous 3 tax years (assuming income and employer contributions were less than £150,000 in each of those earlier years). In this case, a maximum of £130,000 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.

Based on this example, this kind of planning could save tax of at least 40% (£52,000) and, the taxpayer could also keep their tax free personal allowance, despite having income of £210,000.

If you or any of your family, friends and colleagues have income above £100,000, please give me a call to see whether either of you 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.

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