Pension planning in the new tax year

A new tax year always brings a fresh set of allowances to make the most of, along with a few changes to consider. The good news is the main rates of tax relief on contributions, as well as the annual allowances, remain unchanged. Rising wages and the freezing of allowances means that more individuals may benefit from higher rates of income tax relief on contributions.  

For those unaffected by tapering, or unrestricted by the money purchase annual allowance, this is generally good news, with the £60,000 allowance providing adequate scope for most to make reasonable pension provision.

In terms of carry forward, the relevant carry forward years are now from 2022/23 and anything from previous tax years is no longer available. However, you can’t completely ignore prior years as they may be needed to offset any excesses in the three previous tax years. Remember, for the purposes of carry forward, the income in the previous tax years is only relevant where tapering applies. It is not possible to carry forward earnings.

The maximum possible contribution in 2025/26 that can be made, within the annual allowance and with the full three years of carry forward, increases to £220,000. Owners of successful small/medium companies are most likely to be in a position to make use of this, perhaps having neglected their pensions for a few years while building up their businesses.

In relation to tapering, we enter the third tax year with the adjusted income limit set at £260,000 and the minimum tapered allowance of £10,000 once adjusted income reaches £360,000 or more (threshold income remains at £200,000). Watch out for high earners falling into this band through salary increases or bonuses. Adjustments may need to be made to current contribution levels to avoid an unexpected annual allowance charge.

The freezing of the tax bands also means it is likely that many more individuals will fall into the “60% band” where income between £100,000 and £125,140 is subject to this very high marginal rate of tax. Pension contributions remain a very attractive option to reinstate the personal allowance and reclaim this tax. For someone earning £125,140 a pension contribution of £25,140 can be made at a net cost of just £10,056. Even greater savings can be made where salary sacrifice is available.

For tax year 2025/26, a key impact on pension funding is an indirect one – the increase in the employer rate of National Insurance Contribution (NIC). The 1.2% increase makes the advantages of offering salary sacrifice for pensions even greater. Employers make their own decisions regarding how much of the NIC saving they pass onto their employees, with some passing on all and some nothing at all. The change may see more employers willing to set up salary sacrifice and the employee will benefit from at least their own employee NIC savings.

We enter the second tax year of the lump sum allowance (LSA) and lump sum and death benefit allowances (LSDBA). Much of 2024/25 was spent clarifying the new rules and providers trying to implement the changes and correct errors in the original legislation. 

The standard LSA and LSDBA remain at £268,275 and £1,073,100 and are very unlikely to increase in the medium term. Essentially, this means that, whilst tax free cash is limited to £268,275, there is no limit on retirement funds being used to provide an income. Income is of course taxable. However, the tax relief on the contributions is often higher than the tax paid on the income in retirement. This, along with the tax-free growth and income within the funds, means that pension funding is still attractive in many cases, even where no further tax-free cash would be available. 

For those in the decumulation phase, the continued freeze of the personal allowance and the basic rate tax band at £12,570 and £37,700 mean that, unfortunately, there is no scope to increase tax efficient income payments within these bands where they are already being fully utilised. However, the start of the tax year is a good time to review the most tax efficient way of taking money from their pension pots along with drawing from any other savings and investments individuals may have.

One of the biggest changes to pension planning is one that is not planned to be implemented until April 2027 – bringing most pension funds into scope for inheritance tax purposes. Whilst we have two more years until it is implemented, it does mean a fundamental change, particularly for those who had previously expected to use their pension funds as a key part of their estate planning. We await HMRCs response to the initial consultation. However, there seems no sign that the Government will significantly change their position. Individuals are likely to want to start looking at options sooner rather than later and the fundamental change on the horizon needs to be considered in decumulation planning.