Experts have recently warned that thousands of over-55s are at risk of incurring charges and reducing the available tax relief if they continue to delve into their pension pots whilst benefiting from workplace pension contributions. This article takes a look at some key pensions tax reliefs and allowances.
Relief on pension contributions
All pension schemes, whether they are workplace schemes or personal pension schemes, must be registered with HMRC. Money purchase pension schemes allow the saver to receive tax relief on contributions into the scheme, with tax-free growth of the fund. No tax charge is typically payable if the employer contributes into the scheme on the employee’s behalf, and the employer will obtain a deduction from their taxable profits.
Pension savers can make contributions and receive tax relief on 100% of earnings in any given tax year, or on the higher of £3,600. Tax relief is, however, typically restricted for contributions in excess of the annual allowance (see below).
Tax relief on contributions is given at the saver’s marginal rate of tax. Tax relief can be obtained on contributions made to a money purchase scheme via two methods:
- the payment of a net basic rate tax contribution by a member with higher rate relief, which was claimed through the self assessment system
- a net of basic rate tax contribution, paid by an employer to the pension scheme.
In both instances, the pension provider will then claim back the basic rate from HMRC.
The pensions annual allowance
The pensions annual allowance sets a limit on how much an individual can contribute into their pension each year, and still be in receipt of tax relief. The annual allowance is currently set at £40,000. Pension contributions in excess of this amount, including those made by an employer, may be charged to tax on the individual as their top portion of income.
The government is seeking to discourage pension saving in tax-registered pensions beyond the annual allowance. However, many savers are keen to reduce pension saving to below the allowance, rather than incur a charge.
Where total pension savings exceed the £1,030,000 lifetime allowance at retirement (and fixed, primary or enhanced protection is not available), a tax charge arises.
Tapered annual allowance for some
In April 2016, the government introduced a taper in order to restrict the amount of annual allowance available for pension savers with ‘adjusted annual incomes’ (an individual’s net income and pension contributions made by their employer) over £150,000. A saver’s annual allowance is reduced by £1 for every £2 of adjusted income over £150,000, down to a minimum of £10,000.
The Money Purchase Annual Allowance (MPAA)
The government is alive to the possibility of people taking advantage of pension flexibilities by ‘recycling’ their earned income into pensions and immediately withdrawing amounts from their pension funds. The MPAA sets the maximum amount of tax-efficient contributions an individual can make in certain scenarios. The allowance is currently set at £4,000 per annum, with no carry forward of the allowance to a later year.
The main scenarios in which the reduced annual allowance is triggered are if:
- any income is taken from a flexi-access drawdown account; or
- an uncrystallised funds pension lump sum is received.
However just taking a tax-free lump sum when funds are transferred into a flexi-access account will not trigger the MPAA rule.
For information on a range of tax-efficient personal planning strategies, please contact us.
Please note: This article is a commentary on general principles and should not be interpreted as advice for your specific situation.