Pension Contribution Rules
With pensions very much in the news currently it is important that we understand the pension contribution rules. Everyone is aware that pensions, even after they have been much curtailed in recent years, continue to offer very generous tax reliefs which are designed to encourage saving for later life in retirement.
These generous reliefs do however come with limits and as has just been mentioned these are now the subject of a debate with both the Lib Dems and Labour claiming that the reliefs are too generous, particularly for higher rate tax payers. The tax relief limit depends on your own particular circumstances but it is worth knowing that if you exceed your allowable annual limit that there can be tax consequences.
The limit will be either 100% of your annual earnings or the Annual Allowance, whichever is lower. If you don’t earn an income, you can still receive basic tax relief on £2,880 per annum.
You must also consider the Lifetime Allowance which is effectively a cap on the size your pension fund may grow either by contributions, investment growth or both. If your accumulated pension fund grows to exceed this limit there will be a tax charge on any excess when you take your pension.
It is also worth bearing in mind that these limits apply to all your pension savings but do not include your State Pension entitlements. Therefore, if you have more than one pension plan, its the combined total value of all of your pensions including company pensions, personal pensions and any defined benefit pensions. Any and all contributions you may have received from employers along the way will also count towards your Annual Allowance and Lifetime Allowance not just what you have contributed.
The Annual Allowance
The Annual Allowance for the current 2014/2015 tax year is set at £40,000. This amount includes any basic rate tax relief you may be entitled to. To illustrate how this works, if you were contributing the whole amount to your personal pension plan, you could pay in £32,000 and would receive £8000 into the plan by way of tax relief.
It is still currently possible to save more and this is possible by using the ‘carry forward’ rule. This allows you to use any leftover Annual Allowances from the last three years and apply them in the current year to top up your pension and not have any Annual Allowance tax charge.
However, you can only claim tax relief on up to 100% of the value of your earned income in the year.
This year’s Annual Allowance is £10,000 than the previous three tax years, when it was £50,000. This gives you an planning opportunity if you have not made any pension contributions in those years, and you earn more than the Annual Allowance, you would be able to contribute £190,000 this year. If you have used part, but not all, of your allowances, you would get the benefit of the unused excess. If you had contributed £10,000 into your personal pension in each of the preceding three years you would be able to contribute £160,000 this year and receive tax relief.
Watch the small print here though, you can only make use of the previous years’ allowances once you have used the current year’s allowance in full. Also, the three year rule is absolute and any unused allowance from the 2011-2012 tax year will disappear if it is not used for good by the end of the 2014-2015 tax year on 5th April. Finally, you must have had a pension plan in existence during the whole of that period.
In practice, the carry forward rules will be of interest to those who have unused reliefs, who have had fluctuating earnings during the period or who are looking to invest available capital, from bonuses perhaps, tax efficiently.
The Lifetime Allowance
The Lifetime Allowance currently stands at £1.25m. Whilst this may sound like a large sum remember that it covers all your pension funds and plans and also takes account of any defined benefit (final salary) schemes you may have.
Since the applicable tax charge on pension benefits taken with a value above the prevailing Lifetime Allowance can be as high as 55% it is very important to avoid exceeding the limit.
Sadly, we are in a situation which requires very careful monitoring and planning as it is important not to mistakenly breach the limit. Pension plans are an extremely tax efficient way to save, so many of us wish to put as much as possible into our fund but if we enjoy excellent investment growth (one of our key objectives on behalf of clients) this can put up close to or over the limit and thereby expose us to extra taxes we had not expected.
Some who had already accrued larger pension funds may have wisely applied for individual protection (IP) as this gives those who have done so a protected Lifetime Allowance equal to the value of their pension savings on that date, subject to a maximum of £1.5m.
If you are concerned over this point we are happy to assist you consider other ways of tax efficient savings such as ISAs or other vehicles such as Venture Capital Trusts which offer tax incentives in return for investment in higher risk smaller companies.
Finally, for those of you who are married or in relationships don’t forget that these limits apply to everyone and it is worth checking on both sets of fund values for contribution headroom.
As ever, any decisions or advice offered will depend on your own personal circumstances and we stand ready to assist with any questions you may have.
I will leave on the note that the tax year end is fast approaching and should we have a change of government it is looking ever more likely that both the Annual and Lifetime Allowance and their available tax reliefs may come under threat so I would suggest getting to any planning sooner rather than later.
Lee Robertson, CEO
Lee is a Chartered Wealth Manager and is listed in the definitive Spears Wealth Management Index as one of the UK’s top 10 wealth managers. He is a regular contributor to the financial press and is often on television discussing wealth management and investment issues.
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