Personal pensions: What tax relief is available?

Even a mention of the word “pension” can strike fear into some of us, due to the seemingly complex options and regulations surrounding them. However, they can also make a very tangible difference to your financial future.

With the latest statistics show that the number of individuals contributing to a personal pension has increased by 10% but the average contribution decreasing to £2,700 per year, could you be doing more with your personal pensions to safeguard your future?

27th September 2021

What tax reliefs are available on pensions?

The current reliefs on pensions are very generous and make them an attractive place to invest.

Tax relief at your highest rate of Income Tax

For individual contributions, tax relief at your highest rate of Income Tax is available – by way of example, putting £1,000 into a pension will see this immediately grossed up to £1,250 as the Government provide tax relief at source on most modern pensions. Higher rate taxpayers can then reclaim additional tax savings via self-assessment of 20% of the gross payment – in this example, reclaiming a further £250 (for additional rate taxpayers this would be £312.50). As such, the £1,250 now invested in the pension has only cost £750 after 40% tax relief.

High Income Child Benefit Tax Charge

It’s also worth pointing out that additional Income Tax savings can be made for those caught by the High Income Child Benefit Tax Charge (HICBC). Personal pension contributions reduce assessable income and if this then manages to reduce income below £50,000 for the individual concerned, there will be no HICBC, which could potentially save upwards of several hundred pounds.

Earnings between £100,000 and £125,140 and personal allowance

The same applies to those with earnings between £100,000 and £125,140 where personal pension contributions can reduce your assessable income for calculating whether you will lose your personal allowance. Where this works, the effective tax saving on contributions of up to £25,140 is 60%. You can contribute personally into a pension and get tax relief up to 100% of your pensionable earnings, which is typically salary, profit from sole trade or partnership, or furnished holiday let income (net).

Company pension contributions

For business owners facing increasing Corporation Tax rates over the coming years, making company contributions can often be allowable expenses, thus saving 19% tax (although it’s worth noting that Corporation Tax is set to rise to 25%). Company pension contributions are an extremely tax efficient way of moving funds from the company to personal wealth that would otherwise be subject to Income or Dividend Tax. As well as the initial tax savings of making contributions, it should also be remembered that pensions grow free of any Income or Capital Gains Tax and over the years that compounding effect can be significant.

Becoming a basic rate taxpayer upon retirement

When you draw pension benefits, 25% is available as a pension commencement lump sum – also known as tax free cash – with the remaining funds taxed at your marginal rate of Income Tax when you draw upon them. Often as a retiree, you can move from being a higher rate taxpayer to a basic rate taxpayer which can allow you to control the timing and amounts of your pension income so saving tax.

Passing on your pension

Pensions can be inherited and passed on to future generations which can make them extremely effective for succession planning given they are typically not part of someone’s estate and therefore not subject to Inheritance Tax. To find out more, read our post, “Pensions & Inheritance Tax: How to pass on your pensions”.

Can I carry forward my pension’s annual allowance?

The generous tax benefits mean the amount that can be paid into pensions each tax year is restricted.

There is currently an annual allowance of £40,000 per tax year, and this is the total combined sum that can be paid into pensions from you, and any other third party, such as your employer. However, if you were a member of a pension in previous years and did not fully use your annual allowance you can ‘carry-forward’ from the previous three tax years, after first utilising your current annual allowance.

This carried forward relief can be used very effectively by businesses that grow rapidly and then become highly profitable as it’s possible to contribute up to £160,000 (gross) to utilise the current and three previous years’ annual allowances. These contributions should be Corporation Tax deductible.

What is the annual allowance cap for higher earners?

Given the generosity of pension tax relief – which costs an estimated £38 billion a year – the Government introduced a taper for the highest earners, effectively reducing their annual allowance and thus capping their ability to pay larger sums into pensions.

In the past couple of tax years, the income limits on which tapering begins have been relaxed somewhat and as such individuals who might have been caught previously may find that they now have the ability to make larger pension contributions again. For 2021/22, the annual allowance only begins to taper if total income is over £240,000, whereas previously this limit was £150,000. Where income does exceed those amounts the £40,000 annual allowance is reduced by £1 for every £2 over that amount, down to a minimum of £4,000.

We would suggest that those who previously thought they were affected by the old taper threshold, seek advice as it may now be possible to restart contributing again.

At what age can I access my personal pensions?

Draft legislation is now in place which, if passed (as fully expected), will see the minimum age someone can access their personal pension move from age 55 to 57.

As such, it’s important to take stock and consider your financial plans to see if this will affect you and whether further action may be required. The change has been coming to coincide with the increasing age at which you claim your State Pension (which is set to rise to age 68).

There will be a very definite line in the sand based on your date of birth as illustrated below:

  • Those born before 6 April 1971 can continue to draw their pension at age 55
  • Those born between 5 April 1971 and 5 April 1973 will be able to draw their pension from age 55 to 6 April 2028, after which if they have not, the minimum age will increase to age 57.
  • Those born after 5 April 1973 will only be able to draw their pension at age 57.

Given the length of time you may expect to live after age 55, most people do not draw their benefits at the first available opportunity. However, it’s worth considering this if your plans are built around accessing funds at the first opportunity. For example, you may be looking to repay a mortgage if it becomes due at the same time or if you are planning on taking tax free cash to help children onto the property ladder.

Should I make changes to my pension plan and contributions?

It’s never wise to make changes based on conjecture or what may happen in the future, but in the current economic climate the tax advantages of pensions may be in the exchequer’s crosshairs given the huge economic cost of providing financial support during COVID-19. As such we would advocate considering your pension planning opportunities to ensure you are positioned to take full advantage of the various benefits that they can bring, as part of a holistic approach to your personal finances.

To find out more about what we can do to help with your personal pension planning, get in touch.