TAX relief and tax-free growth make a pension contribution attractive at any time.
Higher-rate taxpayers, using their full £50,000 pension annual allowance, can convert a £20,000 tax bill into their own retirement savings but, as the tax year end approaches, I’ve identified seven good reasons for individuals to pay into a pension now. Will one strike the right note with you? (Please note that these recommendations are all based on what I know now and current legislation, not speculation about what might happen in the future.)
1. Obtain personal tax relief at top rates
For those individuals who are higher or additional-rate taxpayers this year, but who are uncertain of their income levels next year, a pension contribution now will secure tax relief at their highest marginal rate.
Typically, this may affect employees whose remuneration fluctuates with profit-related bonuses, or self-employed individuals who have perhaps had a good income this year, but are not confident of repeating it next year. Some careful planning and flexing of the “carry forward” and “pension input period” (PIP) rules give scope for some to pay up to £240,000 tax efficiently in 2013-14.
For example, additional-rate taxpayers this year, worried that income may dip to below £150,000 next year, could potentially save an extra £5,000 on their tax bill if they had scope to pay £100,000 now.
2. Pay employer contributions before corporation tax relief drops further
Corporation tax rates are falling, expecting to reach 20% by 2015. So companies should consider bringing forward pension funding plans to benefit from tax relief at the higher rates. Payments should be made before the end of the current business year, while rates are at their highest.
For the current financial year the main rate is 23%. This will drop to 21% for the new financial year starting 1st April 2014.
3. Sweep-up unused allowance from as far back as 2010-11
Unused pension annual allowance from 2010-11 must be used this tax year or it will be lost forever. For a 40% taxpayer this could mean a missed opportunity to save up to £50,000 at a net cost of only £30,000.
Those already in their 2014-15 PIP, but who still have unused allowance from 2010-11 could start a new contract to sweep this up. A new contract started this tax year automatically has a PIP ending on 5th April 2014, i.e. in the 2013-14 tax year.
4. Make the most of the £50,000 pension allowance
The annual allowance drops to £40,000 from the new tax year. But the PIP rules mean that some people are paying towards this limit already.
“Carry forward” for the three previous years back to 2010-11 will still be based on a £50,000 allowance. But, over time, the new £40,000 allowance will come into the calculation and dilute what can be paid. Therefore, up to £200,000 can be paid to pensions for this tax year without triggering an annual allowance tax charge. By 2017-18 this will drop to £160,000 if the allowance stays at £40,000. One should not ignore the risk of further cuts, either.
5. Recover personal allowances
Pension contributions reduce an individual’s taxable income. So they’re a great way to reinstate the personal allowance and the age-related element of personal allowance for those over 65.
Personal allowance. For a higher-rate taxpayer with taxable income of between £100,000 and £118,880, an individual contribution that reduces taxable income to £100,000 would achieve an effective rate of tax relief at 60%. For higher incomes, or larger contributions, the effective rate will fall somewhere between 40% and 60%.
Age-related element of personal allowance. For someone between the age of 65 and 74, a pension contribution reducing taxable income to below £26,100 will reinstate the age-related element of their personal allowance. The full amount of the age-related element is £1,060 in 2013-14 – a saving of £212. However, the allowance is wiped out once income exceeds £28,220.
6. Avoid the child benefit tax charge
An individual pension contribution can ensure that the value of child benefit is saved for the family rather than being lost to the new child benefit tax charge: this could be as simple as redirecting existing pension saving from the lower earning partner to the higher earner.
Child benefit, worth £2,449 to a family with three children, is cancelled out by the tax charge if the taxable income of the highest earner exceeds £60,000. There is no tax charge if the highest earner has income of £50,000 or less. As a pension contribution reduces income for this purpose the tax charge can be avoided. The combination of higher-rate tax relief on the contribution, plus the child benefit tax charge saved, can lead to effective rates of tax relief as high as 64% for a family with three children.
7. Sacrifice bonus for employer pension contribution
It’s bonus season again. Sacrificing bonus for an employer pension contribution before the tax year end can bring several positive outcomes.
The employer and employee NI savings made could be used to supercharge pension funding, giving more in the pension pot for every £1 lost from take-home pay. And the employee’s taxable income is reduced, potentially recovering personal allowance or avoiding the child benefit tax charge.
As can be seen from the above, there are seven highly attractive reasons for considering making full use of your pension allowances before the end of the tax year. That said, pension contributions may not be suitable for everyone and there can be some complex tax issues surrounding them, as well as restrictions on future accessibility.
This is therefore something you should discuss with your financial adviser and/or accountant before taking any action. However, some careful and creative financial planning is certainly a useful way of ensuring that less of your hard-earned money goes to the Treasury and instead is invested to ensure you have a comfortable retirement.
