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As you are aware the 2019/20 tax year ends on 5 April and there are rumours that Rishi Sunak will announce changes to the tax allowances in the Budget to be held on 12 March 2020.  In the circumstances, therefore, using your allowances where and when possible is so very important.

Pension Annual Allowance

This is the amount that can be contributed into your pension while still receiving tax relief.  This amount is based on your earnings for the year but capped at £40,000.

Pension Contributions

Have you considered your future recently?

Has your income increased significantly or in receipt of a generous bonus?

Have your outgoings reduced, i.e. your mortgage is paid off; your children have ‘flown the nest’ and no longer financially dependent on you?

It is therefore time to refocus on your own financial well being and now would be an ideal time to fast-track your retirement planning and make contributions into a pension and appreciate the generous tax breaks they offer.  On the other hand, you may be concerned about the contribution limits on pensions.

Whilst you can save up to 100% of your salary into a pension and receive full tax relief, you would naturally still be constrained by the annual allowance which has been reduced to £40,000 per tax year.  However, since 6 April 2016, for some individuals who have adjusted income in excess of £150,000, the annual allowance will be further reduced by tapering.

You might ask, are there any options available?  If you have not been contributing your full entitlement over the last three years, then you may still have some unused annual allowances left which can be carried over to the current year – known as ‘carry forward’.

Could you pay more into your pension using the carry forward rule?

Carry forward allows you to make pension contributions in excess of the annual allowance and receive tax relief.  It allows you to utilise any annual allowance that you may not have used during the previous tax years, provided you were a member of a registered pension scheme.  It is only possible to use carry forward if the current year’s annual allowance has been fully used up, i.e. it will have been by the end of the tax year.  You do not need to report this to HMRC.  If you have unused annual allowances from more than one year you will need to apply them in the order of earliest to most recent.

Unused annual allowance can be carried forward to the current tax year from the previous three tax years.  This could be useful to high earners whose allowance has been reduced because of pension tapering.
Pension tapering is when your annual allowance is reduced from £40,000 because your adjusted in come is above £150,000 (which includes employer pension contributions.  Your allowance will reduce by £1 for every £2 of income above £150,000, to a minimum of £10,000.

How does pension carry forward work in practice?

As an example:  Mr Evans earns £105,000 a year and has contributed the following amounts to his pension over the last few years.  His unused Annual Allowance (AA) is also shown.

In total, David has £50,000 of unused AA from the previous three years and £25,000 left from the current year. He can therefore make a further gross contribution of up to £75,000 in the 2019/20 tax year. With the £15,000 he has already saved, his total contributions for the year for which he could receive tax relief on, could be as much as £90,000. This amount is less than he earns and so he is eligible for tax relief on the full amount.

Pension Tax Relief

You are currently entitled to tax relief on pension contributions up to the total amount of your relevant earnings in a year, or £3,600 gross (£2,880 net), whichever is higher. However, there is an upper limit known as the annual allowance which is £40,000 for the 2019/20 tax year.   If you exceed this limit a tax charge may become payable which effectively claws back any excess tax relief given at source.

  • So, if you earn £30,000, you could pay £24,000 into your pension and have it topped up by £6,000 to make a total contribution of £30,000, equal to the amount you earn.
  • On the other hand, if your salary is £80,000, the most you could personally pay into pensions in one year for tax relief purposes without making use of carry forward (see above for details) is £40,000. Remember this is the amount after tax relief has been applied. This means that if you are in a relief at source scheme (explained on page 2) you can contribute £32,000 which will have £8,000 of tax relief added, taking you up to the annual allowance of £40,000.  As you’ll be paying Income Tax at higher than the basic rate of Income Tax you could then claim further tax relief through your tax return.
  • Even if you have no earnings at all, and therefore pay no tax, you can pay £2,880 into a pension plan and have it topped up to make a total contribution £3,600.

You should remember that the annual limit you can receive tax relief on for your pension contributions includes any contributions to a pension made by an employer. If you exceed the annual allowance across all your pension savings, not per scheme, you may have to pay a tax charge on the excess known as ‘the annual allowance charge’. The rate of this annual allowance charge generally will be linked to the highest rate of Income Tax you pay. For more information on the annual allowance please speak to a Financial Adviser.

Reduced allowance for high earners

For most people the annual allowance is usually £40,000 but for some higher earners, i.e. those earning over £110,000 or more, this could reduce gradually from £40,000 to as low as £10,000 (for those who have ‘adjusted income’ of £210,000 or more). This is known as the tapered annual allowance. For more information and to see whether this affects you, your adviser will be able to help.

What if you run your own business?

If you run your own business, the situation is a bit different. One of the advantages of being an incorporated trader is the ability to switch contributions between the individual and the company depending on nature and level of income from the business.
If the individual wants to make the contribution themselves with full tax relief on it, they need sufficient earned income (i.e. salary – dividends do not count for this purpose) to cover the contribution.

The company is able to make whatever contribution it likes to the employee’s pension fund, regardless of the amount of salary/ dividends the employee receives.
It is important that correct legal form is followed here – the company is not making the contribution on behalf of the employee (in which case it would be treated as an employee contribution) but is making an employer contribution in its own right.

As an employer contribution to a registered pension scheme, it does not count towards the employee’s taxable remuneration from the company. The contribution does count towards the employee’s annual allowance, but the individual can benefit from the carry forward rules.

In terms of the company’s profits, the payment is an expense of employing staff and in practice would be allowed as a deduction against trading profits of the company for Corporation tax purposes.  The downside is that if the contribution is significant, it will reduce the amount of profit that is transferred to the company’s distributable reserves, which in turn may limit the amount of dividend that can be paid for the accounting period.

In addition, every deduction against trading profits has to pass a ‘wholly and exclusively for the purposes of the trade’ test. It is important to speak to your tax/financial adviser to see whether it is appropriate to make contributions on this basis.

As always, if you are looking for advice in order to ensure a ‘suitable outcome’ with your financial planning – simply get in touch.

Best Price FS Team