Time may be running out for higher earners to make the most of pension tax relief and the annual £40,000 limit before the government moves the goalposts.
Anyone over 40 is now entitled to a free NHS mind and body health check every five years, at which they might expect to receive the cheerful advice – “use it or lose it”. A wealth adviser or manager looking to keep your finances in top condition might declare the same of your pension.
HMRC estimates the various pension tax reliefs cost it around £40 billion in the 2017-18 year. Chancellor Philip Hammond may now have declared the end of the age of austerity, but government coffers are not awash with cash. Whatever form Brexit takes could bring the chancellor back to the despatch box early in 2019, scrambling for money to plug holes in the national accounts.
So pensions look like the fiscal equivalent of a big, juicy apple hanging within easy reach, just waiting to be plucked. You may want to take a bite while you still can.
This is especially true of those earning over £100,000, because for every £2 you earn over £100,000 you lose £1 of your personal allowance. The effect of this is that your marginal rate of tax between £100,000 and £123,700 is 60%. Therefore, someone earning £123,700 and contributing £23,700 into a pension will save £14,220 in tax.
This is because the government refunds any income tax it has charged when you contribute to a pension. If you are a basic-rate (20%) taxpayer contributing £100 after tax, it will top this up to £125. (That looks like a 25% uplift, but is actually just 20% of £125 – it is simply paying back what it has taken). A higher-rate taxpayer will see £100 uplifted to £167. Many fear the amount of tax relief currently provided may eventually be dropped to a lower flat rate for everyone – another reason for high earners especially to take advantage of what is available now.
Only the basic-rate tax relief of 20% is added to pension contributions by providers at source, so if you are a higher-rate or additional-rate taxpayer you need to claim back the extra relief from HMRC in your tax return. High earners lose out on hundreds of millions of pounds of relief every year by forgetting to do this. If you have not claimed this relief in previous years, you could be in line for an unexpected tax refund – you may need to talk to an accountant or adviser to calculate just how much.
Days numbered for annual allowance
Even if you or your spouse are not earning anything, you can still contribute £2,880 each year (which will be lifted to £3,600). Otherwise, you can only contribute as much as you have earned, up to a limit of £40,000. There is speculation that this limit will be cut too at some point.
Another limit you need to be aware of is the cap on how much you can hold altogether in a pension. The lifetime allowance (LTA), as it is known, is currently £1,030 million, so therefore if you have several pensions, including pensions with previous employers, and are worried that you are close to this limit it is worth taking advice.
Carry forward unused pension contributions
If you are not in risk of breaching the lifetime allowance and have not maximised your pension contributions in the past three years, you also have a window of opportunity to ‘carry forward’ any unused contributions allowance into this year (another benefit that might disappear). If you have earned sufficiently, that means you could be in a position to invest £160,000 into your pension in one fell swoop, saving as much as £74,000 in tax.
There are several caveats. Perhaps the most important is the tapered allowance trap. This reduces your pension contributions allowance by £1 for every £2 of income – which includes earnings, rental incomes and other investment income – over £150,000. It can get fiendishly technical but the tax benefits of paying into a pension and exploiting carry-forward can be substantial.
Another good reason for pumping money into a pension at the moment is that assets within a pension wrapper on your death are not counted when calculating inheritance tax liabilities.
Pension planning should be part of a wider retirement funding strategy that encompasses both partners in any marriage or civil partnership. With smart planning you can significantly reduce the amount you both pay in tax while you are accumulating your retirement pots in these final few years of work, as well as in drawdown. Of course you should review these arrangements regularly, as your circumstances can change. And so – as we may find out this coming year – can the tax regime.
Sean Jones is a financial planning consultant at James Hambro & Co.