In this article we outline some ideas for maximising one's pension contribution in the current tax year and discuss why now may be a very good time to do just that. It should be useful for anyone considering increasing their pension contributions - especially those that are subject to a limited 'annual allowance'.
It is not intended to be financial advice specific to your unique circumstances.
The 'annual allowance' is the amount of your income that can go straight into your pension without incurring income tax. The annual allowance is £40,000 for most workers but can be much lower for higher-earners; it may be as low as £4,000. However there are a few ways in which people subject to a limit on their annual allowance can still make substantial, tax efficient contributions to their pension.
Utilise 'Carry Forward'
Any unused annual allowances from up to three previous tax years can be utilised in the current tax year; this is called 'carry forward'.
There is one catch, which is that you must have been a member of a UK pension scheme - any UK pension scheme - in those previous years. You do not have to have contributed to that pension nor does it have to be worth much; it just has to have existed.
In an extreme but possible example, someone with a £4,000 annual allowance in the current tax year could contribute up to £124,000 to their pension without incurring tax. For a 45% taxpayer this would represent a tax savings of over £50,000! While you may not have quite as much 'carry forward' to use as that, it probably makes sense for you to find out whether you have any available 'carry forward' and, if so, to consider using it.
Contribute To Your Partner's Pension
When one person in a partnership has a limited annual allowance but has excess savings then it can be a good idea for that person to contribute to their partner's pension. This is particularly useful if the partner is a 40% taxpayer as the pension is (usually) topped up by 20% and the partner receives a 20% tax refund - representing a substantial tax saving.
This can be a *really* good idea if the partner earns between £100k and £125k and is therefore subject to the dreaded '60% tax trap'. Avoiding having to pay a 60% tax on income is generally a good idea!
'Carry Forward' could also be applied to the partner's pension so the total amount that could potentially be put into pensions gets to be really quite substantial.
For one, unlike in the movie The 40 Year Old Virgin, if you don't use it then you will lose it! You can only carry forward annual allowances from three years ago, meaning that once that time period rolls off then that tax-free allowance is finished whether you have used it or not.
This year there is a new potential reason to maximise your tax free pension contributions - and it has far more to do with Rishi Sunak than Steve Carrel. There is speculation - and to be clear, it is just speculation at this stage - that the 40% and 45% tax relief on pension will be reduced (perhaps to 20%). To put that in perspective, on a £50,000 contribution to a pension that would represent £10,000 - which is quite a lot of 'extra' tax! While it's never a good idea to take action solely on the basis of rumoured changes to tax law, if it's already a good idea for you to increase your pension contribution this year then the possible changes are another reason to feel good about doing so.
Pension contributions should only be made when the intention is to save for the long-term. Contributing more to your pension now may be a bad idea if you want the money for living expenses, school fees, etc., prior to the age at which you can access your pension (currently 55 but rising).
It would probably help you to decide if the decision regarding pension contributions were part of a holistic financial plan that takes account of both your financial aspirations and how to achieve those aspirations tax efficiently.
If you think you might benefit from professional advice regarding decisions like pension contributions as well as a holistic financial plan, you can learn more about our offering here or contact us below to schedule a complimentary consultation.