By Clare Munro, Tax Partner
When it comes to pension contributions, there is good news and there is not so good news. Let’s start with the not so good news.
If your total income including rental profits, interest, dividends etc. exceeds £150,000, then the amount you can put into a registered pension scheme with tax relief has been reduced for 2016/17 onwards. Those with lower incomes can make contributions of up to the £40,000 annual allowance and obtain tax relief at their highest marginal tax rate. For additional rate taxpayers however, the annual allowance will be 'tapered', so that £1 of relief is withdrawn for every £2 of income over £150,000 until they are left with £10,000 of annual allowance. The result is loss of tax relief worth £13,500 (i.e. £30,000 reduction in annual allowance at 45%).
Many high earners won't have seen the impact take effect yet, but should be on the look-out for potential traps. For example, the £150,000 threshold for the pension taper includes all income and not just your salary or bonuses. Importantly, if your employer makes contributions to your pension, those contributions are added to your income in assessing whether it is over £150,000. Thus, if your salary is £110,000, but your employer contributes £40,000 to your pension, you are considered to have a £150,000 income for pension taper purposes. This means that you will need to keep track of not just your own contributions, but also those made by your employer, if you are to establish what you can pay into the scheme personally without being caught by the pension taper rules.
There will also be situations where employees' income fluctuates from year to year: if you do not know what your next bonus will be then it is hard to take it into account when working out what to pay into a pension fund. There could also be share or stock awards which cannot be valued until they mature or vest. The net result is that high earners will need to be ready to make adjustments to their contributions to take account of additional or unexpected income if they want to avoid additional tax on the excess contributions.
There is some good news too.
If, like many, you have not used up all of the available annual allowance from previous years, then it will be possible to benefit from unused relief brought forward from the last three years. For contributions in 2016/17 the brought forward allowances may be as much as £130,000, although you must have been a member of a scheme in the earlier years in order to benefit. Likewise, the new £10,000 minimum annual allowance, after the maximum taper, can be carried forward and used up to three years later.
Pensions have become a complex area, with restrictions, not just on annual contributions as discussed here, but also on the ability to build up a fund over one's lifetime, so it always pays to take professional advice. Nevertheless, if all else fails for high earners, even without tax relief, the future income from pension contributions will roll up in a tax free environment and 25% can be withdrawn as a tax free lump sum. With the new liberalised environment for pensions, it is also now possible to think of your pension pot as an inheritance tax planning vehicle, with the potential to be passed down the generations as an IHT free fund. At least that’s something to mitigate the trauma of wading through the taper relief rules.
If you would like to discuss your pension, please speak to your contact partner or to Clare Munro, tax partner, firstname.lastname@example.org or Sam Whybrow at Lubbock Fine Wealth Management email@example.com or call one of them on 020 7490 7766.