Tax Relief on Pension Contributions
Saving for retirement is crucial, and the good news is the UK government incentivises this through tax relief on pension contributions. This essentially reduces the amount you pay in tax, effectively putting more money into your retirement pot. Understanding tax relief, including taper relief and carry forward relief, can significantly enhance your pension planning.
Understanding Tax Relief on Pension Contributions
There are two main ways you can benefit from tax relief:
Automatic relief: This applies to most workplace pensions using the "net pay" method. Your employer deducts your contribution before income tax, so you pay less tax upfront. Additionally, some personal pensions use "relief at source," where the provider claims basic rate (20%) tax relief and adds it to your pot.
Claiming relief: If you're a higher-rate (40%) or additional-rate (45%) taxpayer with a relief-at-source pension or contribute to a non-relief-at-source scheme, you'll need to claim the additional tax relief through your Self-Assessment tax return.
The amount of tax relief you receive depends on your income tax band:
Basic rate taxpayer (20%): You get 20% tax relief added to your contributions.
Higher rate taxpayer (40%): You get basic rate relief (20%) automatically, but you can claim an additional 20% through your tax return.
Additional rate taxpayer (45%): You receive the same automatic relief as higher-rate taxpayers (20%) but can claim an additional 25% back again through your tax return.
Here's an example to illustrate the benefit:
Let's say you contribute £100 to your pension.
As a basic rate taxpayer, you get 20% (£20) added automatically, bringing your total contribution to £120.
As a higher-rate taxpayer, you get the £20 automatically but can claim an additional £20 through your tax return, making your effective contribution £140 (a 40% increase).
Annual Allowance and Lifetime Allowance:
There are limits on how much you can contribute to your pension and still receive tax relief. These limits are:
Annual Allowance: This is the maximum amount you can contribute to a tax year (currently £60,000) and receive tax relief. Contributions exceeding this limit may be subject to tax charges.
Taper Relief: How Your Income Affects Tax Relief
While tax relief offers a valuable boost to your pension, your income level can impact how much relief you receive. This is where taper relief comes in.
Taper relief applies to higher earners whose "adjusted income" exceeds £200,000 in a tax year. Adjusted income includes your salary, bonuses, and taxable benefits, along with employer pension contributions. Here's how it works:
As your adjusted income rises above £200,000, your annual allowance for pension contributions with tax relief starts to gradually decrease.
The annual allowance is reduced by £1 for every £2 for individuals who have ‘adjusted income’ over £260,000 a year.
This essentially means that high earners may not be able to contribute as much to their pension and receive tax relief compared to those earning below the £200,000 threshold.
Impact of Taper Relief:
It's essential to be aware of taper relief if you're a high earner or expect your income to increase significantly.
You can use government-provided tools to estimate your adjusted income and the potential impact of taper relief https://www.gov.uk/tax-on-your-private-pension/pension-tax-relief.
Strategies for High Earners:
Contribute before exceeding the £200,000 threshold: If possible, maximise your pension contributions before your income reaches the taper relief threshold.
Utilise salary sacrifice: This lets you agree with your employer to reduce your salary in exchange for a higher pension contribution (up to your annual allowance). This reduces your National Insurance contributions as well.
Explore alternative retirement savings options: Consider ISAs (Individual Savings Accounts) specifically designed for retirement savings, these contributions don't benefit from tax relief on contributions like pensions.
Carry Forward Relief
The good news is that the UK tax system offers carry-forward relief, allowing you to make use of any unused annual allowance from the previous three tax years. This means you can potentially contribute more in the current year and still benefit from tax relief.
How carry-forward relief works:
Unused Allowances: If you haven't contributed the full annual allowance in a previous tax year (as long as you were a member of a registered pension scheme during that time), you can “carry forward” that unused allowance to the current tax year.
Maximising Contributions: By combining your current year's allowance with any unused allowances from the previous three years, you can potentially make a larger pension contribution and receive tax relief on the entire amount.
Priority of Use: Carry forward allowances are used in chronological order, starting with the earliest unused allowance. So, if you have unused allowances from multiple years, the one from the furthest year back will be used first.
Reporting Requirements: You typically don't need to inform HMRC about using carry-forward relief. Your pension provider should handle the calculations and ensure your contributions receive the appropriate tax relief.
Benefits of Carry Forward Relief:
Boost Retirement Savings: Carry forward allows you to significantly increase your pension contributions in a single year, accelerating your retirement savings plan.
Flexibility: This option provides flexibility, especially if you haven't been able to utilize the full annual allowance in previous years due to income fluctuations.
Tax Efficiency: By maximising your contributions with tax relief, you reduce your current tax liability and build a larger tax-advantaged retirement pot.
Things to Consider with Carry Forward Relief:
Annual Allowance Limits: Remember, the total amount you can contribute (including carry forward) remains capped by the current year's annual allowance.
Earnings Impact: Be aware that exceeding the combined allowance (current year + carry forward) may result in tax charges on the excess contribution.
Future Income: If you anticipate a significant income increase in the future, it may be more beneficial to save your carry-forward allowances for those higher-earning years when you can utilise the larger annual allowance.
If you think you need some help in preparing your self-assessment tax relief to take advantage of pension relief and the available allowances. Then please contact jreeves@taxmatters.tax to arrange a call to find out how the Tax Matters team can help you.