At this time of the tax year when attention turns to tax planning, pension contributions can be an excellent way of both saving tax and contributing to your future retirement plans.
How it works
Each time you pay into your personal pension plan, the government adds another 20%, as an additional deposit into your pension pot.
For example, if you are an employee earning £20,000 gross, you can get relief for payments into your pension of up to £16,000. For every £1,000 you pay in, the government adds another £250. Contributions in excess of your pensionable earnings generally will not attract the top-up, however if you earn less than £3,600 each year (or even nothing at all), you can still make net contributions of up to £2,880 and receive up to £720 in government top-up. You can even start a pension for children or grandchildren and they can benefit from the top-up too!
In addition to the 20% top-up, higher-rate taxpayers can claim a further 20%, and additional-rate taxpayers can claim an extra 25%. The higher rate reliefs are given either via your Self Assessment Tax Return, or by asking HMRC to make an adjustment to your PAYE tax code.
If you are part of a workplace pension, under a net pay arrangement you might not need to reclaim this additional income tax relief, as your employer will deduct the contributions from your gross pay, before calculating income tax and National Insurance, so tax relief is already given before calculating your net pay.
Tax relief is restricted if your total gross pension contributions (the net amount you actually pay in, plus the 20% government top up) exceed the lower of your "Relevant Earnings"; or the "Annual Allowance". What do these terms mean?
Not all income is classed as “relevant earnings” for pension purposes, even if it’s taxable for income tax purposes. Common income sources that don’t count as relevant earnings include: rental income (but Furnished Holiday Let income does), pension income, bank interest, and dividends.
Regardless of your earnings, the absolute maximum that you can contribute into a pension in the current tax year without incurring punitive tax charges is normally £40,000 (this allowance is tapered for anyone earning over £150,000 per year). This amount includes employer and third-party contributions as well. So even if your relevant earnings were £60,000, gross pension contributions would normally be restricted to £40,000.
If you wish to exceed this limit, you may be able to use up unused Annual Allowance from the three previous tax years, provided you held a personal pension plan in the tax year(s) you are carrying forward (even if you did not make any contributions at all in those years).
If you exceed the Annual Allowance (current year and any carried forward), you will not qualify for tax relief on the excess, and you will have an Annual Allowance charge to pay. This is expensive!
If you or partner claim Child Benefit, and one or both of you have ‘adjusted net earnings’ over £50,000, you are normally required to repay some or all of the Child Benefit received. However, by making pension contributions you may be able to reduce your adjusted net earnings below the £50,000 threshold, in which case you will no longer need to repay Child Benefit.
Accessing your pension pot
Currently, you can access your pension once you turn 55, so pension contributions can prove to be an especially useful tax-saving device if you are nearing retirement. Under current rules, on retirement 25% of your pension pot can be taken tax-free, with the remainder taxable at your marginal rate along with your other taxable earnings – again, with forward planning, we can help to ensure that any withdrawals are tax-efficient.
Even if you are already accessing your pension, you may still be able to claim some tax relief on contributions until you reach 75 years old.
Employer pension contributions for the owner-managed company
Pension contributions made by your employer aren’t subject to the relevant earnings limit – so if you currently take a salary of only £8,000 from your personal company, the company could still make a pension contribution of up to the Annual Allowance of £40,000, even though you personally would be limited to £8,000 gross contributions.
It is important to note that employer contributions will not save you income tax personally, however the company should generally be able to claim the contributions as a deductible trading expense to save corporation tax, provided that it meets the normal “wholly & exclusively” requirement for allowable expenditure. If it's your company, everybody wins!
Tax relief for pension contributions already made
Finally, if you are a higher-rate or additional-rate taxpayer who has made personal pension contributions in the past, and think you might be due some income tax relief, the good news is that it might not be too late to make a claim to HMRC – the deadline for making repayment claims is four years after the end of the tax you are claiming for, so you have until 5 April 2018 to make a claim for the tax year ended 5 April 2014. Please contact us today if you think you might be eligible for further tax relief.
We like to help our clients manage their tax affairs effectively, so if you'd like to discuss how we can help you or your business today, please don't hesitate to get in touch.