Tax treatment of pension contributions – key points
We understand the concerns you may have about your financial security when you retire. Saving into a pension can be a tax efficient way to save for your retirement. Our Wealth Management and Tax team can assist you with:
- Setting up a pension fund
- Calculating the most tax efficient amount to save
- Utilising allowances from previous years
- Reviewing your existing pension arrangements
- Cashflow modelling
- Creating an investment strategy to suit your personal requirements
WHY SAVE INTO A PENSION?
A pension is a long term savings plan with the benefit of tax relief. Having a clear idea of your financial position on retirement will ensure you plan appropriately. When you make a pension contribution into a private fund, you instantly obtain tax relief as your contribution is treated as if it is made net of basic rate tax. For example, if you make a contribution of £5,000, this is grossed up by 20% and the amount invested in to your fund is £6,250. If your employer arranges for your pension contributions to be made, they will usually do this by deducting the amount to save from your gross income, meaning you will not be taxed on this amount.
HOW MUCH CAN I SAVE?
You can save as much as you want into your pension fund, but there are caps on the amount you can save for tax relief:
- Relevant earnings
You can save up to 100% of your relevant earnings in the tax year, or up to £3,600 if your earnings are below £3,600. Only earned income qualifies as ‘relevant earnings’, so dividend income or pension income do not qualify.
- Annual allowance
The annual allowance determines the amount of pension savings you can make and receive tax relief on. As an example, the standard annual allowance for 2018/19 is £40,000, therefore you can only make pension contributions up to £40,000 otherwise you will incur a tax charge on excess contributions made above this amount. The charge will be at your marginal rate of tax. The annual allowance is currently set as £40,000 and you can utilise any unused allowances from the previous three years. A specific order is applied when utilising unused allowances. It is important to note that employer contributions into your pension fund count towards your savings for your annual allowances. It is important to check the total paid in to your fund from all sources when considering your annual allowance limit. From April 2016, high earners (net income over £150,000) receive a reduced annual allowance. The annual allowance is reduced by £1 for every £2 earned over the threshold. The minimum allowance is £10,000.
HOW MUCH TAX RELIEF CAN I GET?
You automatically receive tax relief when you make a pension contribution to your private fund. This is because your payment is treated as being made net of basic rate (20%). If you are basic rate taxpayer you have essentially received your full tax relief at this point. However, if you earn above the basic rate band of £46,350 (assuming you are entitled to a full personal allowance) you will pay tax on some of your income at the higher rate of 40%. If you earn above £150,000 you will pay tax on some of your income at the additional rate of 45%. As you have only received relief at the basic rate of 20% for your pension contribution, you are entitled to further relief and can claim further tax relief for your contributions up to 40% and 45%. Example: You earn £95,000 and are a higher rate (40%) taxpayer. You make a net pension contribution of £20,000 in the tax year. This is treated as net of basic rate tax of £5,000, making your gross contribution in to your fund £25,000. You have received initial tax relief of 20% (£5,000) but you are a higher rate taxpayer, so can claim further relief of 20% (£5,000) to ensure your total tax relief is £10,000, which is 40%.
A personal allowance is the amount you can earn before you start paying Income Tax. The personal allowance for 2018/19 is £11,850. However, your personal allowance is withdrawn if your net earnings are above £100,000. It is reduced by £1 for every £2 earned over the threshold. Pension contributions reduce your income to determine your entitlement to the personal allowance for the tax year. It can be a useful planning tool to ensure you do not lose your personal allowance. Annual allowance If you are a high earner and your pension savings annual allowance may be reduced, you can plan ahead to ensure your pension savings are structured and your full allowance is retained, depending on your income level and employer contributions. Lifetime allowance If the value of your pension benefits exceeds the lifetime allowance, any excess will attract a tax charge if it is withdrawn as income. The lifetime allowance is currently £1.03 million. It is beneficial to check how much of your limit you have used and if you have the opportunity to make a claim to protect your allowance from the reduced rate that was introduced in April 2016.
The information provided is a brief overview of what can be a complex area and we encourage you to seek professional advice before arranging pension contributions. All examples are based on English law and therefore if you are based in Scotland please note the tax rates may differ. Please contact our Tax or Wealth Management team if you require any assistance or further explanations on the points raised.
Tait Walker Wealth Management is a trading style of Tait Walker Financial Services Ltd which is authorised and regulated by the Financial Conduct Authority. Company Number 5674020. Incorporated in England.