As the government starts to explore ways to repay the mounting debt from coronavirus, one area which may find itself under the spotlight in the planned budget for the 3rd March 2021 is a potential reduction to tax relief on pension contributions, but why is this of such importance?
First of all pensions are very tax-efficient.
Right now all contributions within allowance limits receive tax relief from the Government payable at up to your highest rate of tax. For example, it would only cost a basic-rate taxpayer £8,000 to contribute £10,000 into their pension because they would receive basic rate tax relief at 20%. A £2,000 immediate uplift just by making the contribution. For higher earners, it is even better, with higher-rate taxpayers able to then claim back up to a further £2,000 and additional-rate taxpayers up to a further £2,500 via self-assessment, on the same level of contribution. Tax relief is given on personal contributions up to 100% of your earnings (or £3,600 if greater). However, if total contributions from all sources, including your employer if applicable, exceed the Annual Allowance you will suffer a tax charge on the excess funding.
The Annual Allowance limits how much can be paid into a pension arrangement on which you can receive tax relief. It’s currently set at £40,000, however, most people do not currently contribute anywhere near this level to fully utilises their annual allowance.
In addition, if you’ve not used your full Annual Allowance in the current or any of the previous three tax years, you can legitimately pay in more than the annual limit by utilising Carry Forward. This allows, in certain circumstances, up to £160,000 in total to be contributed. At even basic rate tax relief a £160,000 gross pension contribution would only mean a £128,000 net pension payment, an uplift of £32,000 effectively before the funds are even invested. There is clearly even more benefit for higher rate earners, which will be the case with any contributions of this level, with an additional £32,000 of tax relief available. A £160,000 pension contribution has therefore cost only £96,000 net in this example, with total tax relief of £64,000 gained.
To qualify for Carry Forward, you must:
The maximum you can carry forward depends on how much Annual Allowance you have left. You must first use up the Annual Allowance in the current tax year before going back as far as the three previous tax years.
When working this out, you should include any pension contributions made personally as well as your employer, plus pension benefits built up in a final salary pension scheme.
On 6 April 2016 new rules were brought in on the amount you earned before it affected the tax relief you could benefit from. Those with a ‘Threshold Income’ over £110,000 and ‘Adjusted Income’ over £150,000 found their Annual Allowance reduced by £1 for every £2 of income in excess of this figure until it reached initially £10,000, which was then further reduced by subsequent rules to just £4,000. This is called the Tapered Annual Allowance.
However, in the Budget last year The Chancellor announced a relaxing of these rules on how much high earners can save into their pensions while receiving tax relief. For the 2020/21 tax year, both limits were lifted by £90,000 resulting in Threshold Income limit of £200,000 and Adjusted Income limit of £240,000. Only when both of these revised limits are breached will a person be subjected to Tapered Annual Allowance i.e.. a reduction in their Pension Annual Allowance. However, this also could also potentially be reviewed in the budget to help balance the books.
Pensions continue to offer an extremely valuable and effective means of retirement saving and for most people. The State Pension, which for many now won’t become payable until their late 60s, just isn’t sufficient to maintain a comfortable lifestyle. If you have the chance to make some additional contributions, including catching up on unused allowances then now might be the time to do so before the end of the current tax year.
At Armstrong Watson, our quest is to help our clients achieve prosperity, a secure future and peace of mind. Our guidance for anyone considering taking personalised financial advice and planning for retirement is that now may be a good time to consider this whilst all the current existing reliefs and allowances remain available for those who are in a position to take action.