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.
To view the Prosperity newsletter in full, please click here.