Your pension is one of the best tools to save for retirement. Not only does it allow for tax-free investment growth, but the UK government will also “boost” your contributions (via tax relief). Yet despite the huge benefits of pension allowances, they remain little-understood – often leading to costly mistakes. In this guide, our financial planners at Vesta Wealth in Carlisle, Cumbria offer this short guide on allowances and getting the best from your pension. This forms the first in a multi-part series about other tax allowances, helping you put more money back in your pocket.
What are pension allowances?
Your pension allowance is the limit that you can put into your pension pot(s) whilst continuing to get generous tax benefits. There are two main types of allowances available to each person: the annual allowance and the lifetime allowance. If you go over the limits involved with either, then unpleasant tax penalties can apply – undermining your retirement fund.
What is the UK annual allowance for pensions?
The annual allowance (limit) on pension contributions is £40,000 per tax year; or, up to 100% of your income if this is below that. For instance, if you earn £100,000 per year then only £40,000 can receive tax relief. If you earn £35,000, however, then only £35,000 can receive tax relief.
The tax relief available on personal pension contributions is equivalent to your highest rate of income tax. So, if you earn £60,000 per year in salary, then you are a Higher Rate taxpayer and so your pension contributions get 40% tax relief. In effect, this means it only “costs” you 60p to put £1 into your pension. A Basic Rate taxpayer gets 20% tax relief.
This is why it is so essential to make the best of your pension contributions. Over the years, this can result in £1,000s of “free money” from the government towards your retirement. One area where some people can lose out is by not claiming additional tax relief if they are eligible. Tax relief of 20% is automatically applied at source by your pension provider on personal contributions. However to receive additional tax relief if you are a higher or additional rate taxpayer then this needs to be claimed on a self-assessment tax return.
Higher earners should note, however, that a taper applies to the annual allowance. This lowers how much some individuals can put into their pension each year. This may apply to you if you earn over £200,000 per year (check with your financial planner). Here, your annual allowance is reduced by £1 for every £2 you earn over £240,000 in “adjusted income” (i.e. all of your income, including pension contributions).
For example, if your adjusted income is £270,000 then your tapered annual allowance should be £25,000 (not £40,000). The lowest a tapered annual allowance can fall is £4,000.
Another pension rule that can lower your annual allowance is the Money Purchase Annual Allowance (MPAA). This is triggered by an individual who takes certain actions with his or her pension (e.g. taking money from a pension pot) and reduces your annual allowance to £4,000 per year. The rules here are complicated, and it is best to seek professional advice before doing anything with your pensions to make sure you do not trigger the MPAA inadvertently.
Once it is activated, it cannot be undone and can undermine your remaining retirement plans.
What is the pension lifetime allowance?
Not only is there a limit on your total annual pension contributions; there is also a total “cap” on how much you can have saved in your pension pot(s) without a tax charge – called the Lifetime Allowance (LTA). In the 2022-23 tax year, this is set at £1,073,100.
If you exceed your Lifetime Allowance, then a 55% tax charge is levied on any lump sum taken above the threshold (25% for anything taken as income). Under the 2021 Budget, the LTA has been frozen until April 2026 – it will not rise with CPI inflation as it has typically done before.
It is important to plan ahead to make sure you do not unwittingly trigger a LTA tax charge. For instance, turning age 75 without accessing any pension benefits will trigger a LTA “check”. This can trip up those who hoped to pass down a large portion of their pension savings to loved ones when they die (since pension pots are generally exempt from inheritance tax).
How to get the best from your pension allowances
A financial planner can help you craft a truly tailored plan to make sure you get the best from available pension tax benefits. However, here are some ideas to consider:
- Claim all eligible tax relief (remember, Higher Rate and Additional Rate taxpayers need to claim anything above Basic Rate tax relief via Self Assessment).
- Contribute on behalf of your spouse or civil partner (they get their own allowances!).
Maximise your employer contributions. If they offer to match your own contributions up to a certain point, for instance, then this is “free retirement money” for the taking. - Use pension “carry forward” rules if they apply to you. Here, you can access any unused annual allowance from the previous three tax years.
Invitation
If you would like to discuss your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.