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Resources

Pension contributions – the tax benefits

Resources

Pension contributions – the tax benefits

This page was last updated on July 14, 2023
In the latest Finance Act, the Government introduced changes which impact pensions. These changes will have a significant effect on the level of pension contributions which can be made without incurring a tax charge. Here we summarise the current position.

Tax relief on pension contributions

Historically, there have been three ways in which tax relief on pension contributions is applied:

The annual earnings limit

The absolute maximum level of pension contributions that you can make with tax relief is restricted to your ‘relevant UK earnings’ taxable in the year, or £3,600 if you have no such earnings or they are below that level. 

Broadly speaking, the relevant UK earnings include your employment and self-employment income, any furnished holiday letting and some patent income.

It does not include investment income. Employer contributions to your pension are not, however, restricted to earnings.

The annual allowance

If your ‘total pension inputs’ exceed the annual allowance of £60,000 (previously £40,000) there is a tax charge on the excess at your marginal income tax rate. Your total pension inputs include:

The lifetime allowance

If you took your pension prior to 6 April 2023 there was a tax charge if your total pension pot exceeded the lifetime allowance, which was £1,073,100 in recent years.  However, this charge was abolished for 2023/24 and the Government has said that the allowance will be abolished altogether.  A change of Government could of course reverse this.

THE ANNUAL ALLOWANCE

The annual pension allowance changes in the following circumstances:

Carry forward

If you have not fully used your annual allowance in a year, any unused amount can be carried forward for up to three years.

Money-purchase

If you have already started drawing your pension, the annual allowance is reduced to £10,000 (previously £4,000).

Tapering

If your ‘adjusted income’ (that’s your total income before pension contributions plus employer contributions) is more than £260,000 for the tax year, the annual allowance is reduced by £1 for every £2 that your adjusted income exceeds £260,000. It then tapers down to a minimum of £10,000 which happens when your income is £360,000. 

This reflects the recent changes that the £260,000 level was previously £240,000, and the £10,000 minimum had been £4,000.

If your ‘threshold income’ (total income excluding pension contributions) is no more than £200,000 you will not suffer the reduction.

A very simple example

Say you have an adjusted income of £310,000 for the 2023/24 tax year.  This exceeds the adjusted income limit by £50,000.

Your annual allowance would be reduced by half of this (so by £25,000) leaving you with a tapered annual allowance of £35,000.

This is the standard annual allowance of £60,000 less the £25,000 reduction under the tapering rules.

Making pension contributions in excess of the allowance

There is no limit to how much you can contribute to a pension scheme, but if…

…in excess of the allowance, you should include the excess amount on your self-assessment tax return. It will mean you will have an income tax charge at your marginal rate.

If the tax charge is more than £2,000, you can elect for your pension scheme to pay the charge on your behalf. This may however result in a reduction to your pension at retirement.

Many people in defined benefit (‘final salary’) pension schemes have found that a modest increase in their pay can result in a tax liability that is greater than the pay increase.

Qualifying for tax relief on pension contributions

To get tax relief on pension contributions you must be a ‘relevant UK individual’ which includes someone who:

The pension scheme must also be registered in the UK.

Age implications

Tax relief is available on pension contributions made from birth.  So, parents or grandparents could make contributions on behalf of a child, up to £3,600 gross (£2,880 net) even if the child has no earnings. 

The child receives the tax relief but there could also be inheritance tax savings, for example if the annual exemption is used or if they become ‘normal expenditure out of income’ for the parent or grandparent.

There is no tax relief for personal pension contributions made after you reach the age of 75, although relief is still available (for the employer) for employer contributions.

High income earners

60% (63% if Scottish tax rates apply) tax relief is available if your income is between £100,000 and £125,140.  This is because the personal allowance is then tapered, so you are paying 40% tax on the lost allowance as well as 40% tax on the income. 

Be aware that the personal allowance disappears altogether when your income reaches £125,140.  Pension contributions reduce your adjusted income, so personal allowances would be reinstated if your contributions can reduce that to £100,000 or less. 

If a salary sacrifice arrangement is in place, the tax relief rises to 67% (70% if Scottish rates apply).

Changes to be alert to

Although the lifetime allowance is being abolished, the maximum tax-free lump sum is frozen at 25% of the last lifetime allowance in force i.e. £1,073,100 @ 25% = £268,275.

From 6 April 2023, the tax rate changed from 55% to the individual’s marginal income tax rate (20%, 40% or 45%) for any of the following:

If you have enhanced or fixed protection (available when the lifetime allowance was reduced in previous years) with a certificate or reference number received before Budget Day on 15 March 2023, you can have a ‘protection cessation event’ and not lose your higher tax-free cash.

CAN WE HELP?

If you need further guidance about any of the information outlined here, please speak with your usual Shipleys contact or one of our team of specialists shown on this page.


Specific advice should be obtained before taking action, or refraining from taking action, in relation to this summary. If you would like advice or further information, please speak to your usual Shipleys contact.

Copyright © Shipleys LLP 2023

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