Increasing the amount you contribute to a pension is an effective way to save for retirement while also reducing your annual Income Tax burden.
Under most circumstances, payments made into a pension scheme are tax-free as long as they don’t exceed the UK’s pension allowances.
The annual pension allowance sets a cap on the amount of tax-free contributions and benefits that can be paid into defined contribution and defined benefit pension schemes each year.
The Annual Pension Allowance
For most taxpayers, this limit is currently £40,000 per year, though a reduced allowance of £4,000 may apply if you’ve already accessed your pension.
It’s worth noting that the annual pension allowance applies across all pension schemes held by a taxpayer, including contributions made by the individual, their employer, and any third parties.
Unused allowances from the previous three tax years can be carried forward if the annual limit was not fully used.
If you’ve used flexible pension benefits and plan to continue making contributions to a defined contribution pension scheme, the money purchase annual allowance (MPAA) applies.
The MPAA restricts contributions to £4,000 per year if you’ve withdrawn more than 25 per cent of your pension tax-free. There is no option to bring forward unused annual allowances from previous tax years.
High earners should be aware of the tapered annual allowance (TAA), which further limits the amount of tax relief they can claim on their pension savings.
The TAA reduces the annual allowance to as low as £4,000, depending on an individual’s income. For every £2 of “adjusted income” above £240,000 per year, £1 of annual allowance is lost.
The TAA does not affect those with a threshold income of £200,000 per year. Unused allowances from previous tax years can still be carried forward if the TAA applies, provided you had an open pension in those years.
The Lifetime Pension Allowance
The lifetime pension allowance caps the total value of all pensions held by an individual, excluding the State Pension.
For most taxpayers, this allowance is currently set at £1,073,100. Any payouts from pension schemes exceeding this lifetime limit are subject to a lifetime allowance charge.
Reducing your Income Tax bill
Making additional payments into your pension through your earnings reduces the amount of taxable income you earn.
As part of a wider tax plan, it can help you to reduce the amount of tax paid at higher marginal rates, or depending on your circumstances, carry your earning into a lower tax band.
With the threshold for the additional rate of income tax (45 per cent) falling in April to £125,140, pensions could be a great way of managing your personal tax liabilities in future.
For advice on pension contributions, Income Tax and financial planning, contact us today.
