Lock In Tax Relief By Topping Up Your Pension Fund Before 5 April

Any financial advisor will tell you it’s never too early to start paying into your pension fund, but what many don’t necessarily appreciate is the significant tax savings that can be made whilst also building a secure plan for retirement.

The UK’s income tax approach to contributions is pretty generous, i.e. not only do you get full tax relief at your highest tax rate (up to 45% in the UK and 48% in Scotland) on qualifying pension contributions, but the fund itself then grows in a completely tax-free environment, with full exemption from inheritance tax. The UK currently has the highest tax rates for over 70 years, so paying into a pension that ultimately benefits your future and family, whilst also saving tax, must surely be seen as a genuine win.

However – and yes, you guessed it, there is always a ‘but’ – given the very generous tax relief available on contributions going into a pension, in order to secure such tax relief, there are unsurprisingly, various limits/ allowances that must be adhered to. For those attempting to maximise their pension contributions, they must be fully aware of the rules.

Annual Allowance

The annual allowance, set by HMRC, is the most you can save into your pension pot relative to the current tax year. This is £60,000 for 2023/24 and it applies to all contributions made across all pensions held, whether contributions are paid by you personally or by your employer.

Tapering for High-earners

The £60,000 allowance is also tapered (reduced), for high earners. Essentially the allowance is reduced by £1 for every £2 of your ‘adjusted income’ that exceeds £260,000. Adjusted income also includes employer pension contributions that have received tax relief at source, eg salary sacrifice arrangement.

Note that the annual allowance will not be tapered if your ‘threshold income’ is £200,000 or less. It is therefore important to determine what your ‘adjusted income’ and ‘threshold income’ is in each case. The broad difference between each calculation is that the threshold calculation requires a deduction for personal pension contributions, i.e. those contributions paid net of basic rate tax. The different income calculations can provide surprising results and so it’s important that professional advice is taken, to ensure contributions are based on the correct allowance calculations.

The £60,000 will be tapered down, according to excess income, but will stop at £10,000. It follows that £10,000 is the absolute minimum allowance for those with adjusted income that exceeds £360,000.

If you choose to make a withdrawal from a defined contribution scheme, then you may trigger a permanent reduction in your available allowance in all future tax years which is currently also set at £10,000. (£4,000 in previous years)

Unused Annual Allowance

Any unused allowance can be carried forward for 3 tax years, so if we look at the current tax year 2023/24, you can utilise unused allowances brought forward from 2020/21, 2021/22 and 2022/23. To secure this carry-forward, you must also have been a member of a registered UK pension scheme during each of those tax years, even if the pension input for that year was nil.

The annual allowance for the current tax year is always utilised against pension contributions first, then the method of set-off is essentially first in first out, i.e. the earliest years unused allowance is used first, before the later years.

Net Relevant Earnings

Where you are personally paying pension contributions, you must also be able to demonstrate that you have earnings of the same amount to ‘frank’ the gross pension contributions being made in any tax year. If your employer pays the pension contribution relevant earnings are not necessary. If paid personally, however, any excess contributions made will not receive tax relief and in most cases, pension funds will insist on issuing refunds of contributions that do not receive tax relief

It follows then that if you are in the fortunate position to have unused allowances brought forward and wish to pay a lump sum into your pension to utilise these allowances, you must also ensure that you have enough earnings to be able to claim associated tax relief.

Tax Charge where contributions exceed Annual Allowances

If you find that you may have exceeded the annual allowance amount (including any allowances brought forward), HMRC will charge tax at your highest rate on the excess and will also expect you to ‘self-assess’ this tax charge on your tax return.

This can often happen if you are a member of a Defined Benefit or Final Salary arrangement, where notional pension contributions can be far in excess of what the individual believes is being contributed in cash terms.

There is however, an option available to ask that the scheme pick up this tax charge on your behalf, but only if the charge is in excess of £2,000 and a formal election is made to that effect within the timescale required, which is 31 July in the year following the tax year.

Lifetime Allowance

The good news is that following the Spring Budget in March last year, the Lifetime Allowance (LTA) is to be abolished. The (LTA) is a limit on the total amount of pension benefits that an individual can receive from all registered pension schemes, without triggering an additional tax charge. However, the maximum tax-free cash going forward will be capped at £268,275, which is 25% of the existing £1,073,100 LTA, except where existing protections apply.

TAX YEAR-END PLANNING – OTHER TAX POINTS TO NOTE AHEAD OF 5th APRIL

Other than pension planning, there are other taxation changes that are important to be aware of, and for which it’s important to ensure you are taking advantage of the available relief and allowances:

• For Scottish rate taxpayers, from 6 April 2024 a new advanced rate will be added at a rate of 45p for earned and property income between £75,000 and £125,140, and the rate on the top rate band on any earned and property income over £125,140 will be increased to 48p. The other types of income such as dividends or savings income for Scottish rate taxpayers will remain at the same rates as the rest of the UK, therefore it is important to check if you and your partner have considered whether income-generating assets could be better shared to save tax.
• The dividend allowance is currently £1,000 and this will be reduced to £500 from 6 April 2024, therefore if you can influence the timing of dividends from shareholdings, and consider whether these can be accelerated to before 5 April 2024.
• Charitable donations – accelerate donations to claim higher rate tax relief.
• The Capital Gains Tax Annual Exempt Amount is currently £6,000 and this will reduce to £3,000 from 6 April 2024. Therefore, if you can influence the timing of selling any shares, property, etc., consider whether these can be accelerated to before 5 April 2024. However, with the reduction in the higher rate of Capital Gains Tax on residential property sales from 28% to 24% taking effect from 6 April 2024, it may be more beneficial to delay such sales in many circumstances.
• Adult ISA you can pay a maximum of £20,000 a year and a Junior ISA a maximum of £9,000 a year.
• Regular Gifts out of Income and Gifts Exemption – make use of the £3,000 annual gift exemption and make gifts from surplus income to reduce the value of your estate exposed to Inheritance Tax.

If you require any assistance with pension planning or tax year-end planning and understanding the various options that are available to you before the end of the current tax year, please do not hesitate to get in contact with Lynn Gracie, Tom Andrew, or your usual Sagars contact.