End of tax year pension planning

As ever, in the run-up to the Budget, there are rumours and speculation that the generous reliefs offered to pension savers may be cut. This year, given the massive Government Debt that has arisen as a result of the financial support measures introduced in 2020, a raid on pension tax relief could be more likely.  In recent years, the most popular rumour is that of cutting tax relief for higher rate and additional rate taxpayers. As we have seen in the past, there are several issues with this including how it would work with net pay contributions, employer contributions and defined benefit schemes. There is also the impact of this on the public sector and in particular the NHS, which would be politically very difficult in the current climate.

However, it may be worth considering making any contributions before the 3 March Budget day, rather than the tax year-end just in case there are any immediate changes. And where a client can achieve higher rate tax relief or greater it may be worth maximising contributions while we know it’s still available.

Of course, the tax benefits of personal contributions are subject to limits. Firstly, tax relief is limited to the higher of £3,600 gross and the client’s relevant UK earnings, which primarily means any income earned from employment or trade and doesn’t include investment income such as dividend income or rental income (apart from certain holiday letting income).

Unfortunately, many - particularly amongst the self-employed, have seen their earnings reduce in this tax year so it is also worth making sure clients haven’t paid in more than their relevant earnings. If they have, this is one of the few situations where the provider can make a refund of any excess contributions.

This tax year has also seen an increase in redundancies. The taxable element of the redundancy payment does count as relevant UK earnings and making contributions can be beneficial, particularly for those near retirement age and those who find new employment promptly.

The tax benefit of contributions is also restricted by the client’s available annual allowance which can be as low as £4,000 and up to a maximum of £160,0000 where carry forward is available.  The £4,000 minimum can apply both where the client has triggered the money purchase annual allowance and where the client is a very high earner with adjusted income is £312,000 or more.

For those subject to the tapered annual allowance in previous tax years, it is worth checking if there is any scope to increase contributions now the limits have substantially increased. Those limited to £10,000 in earlier years may now have scope to pay more in and possibly have their full £40,000 allowance restored. With many companies reducing bonus payments for 2020 this may also bring more client’s outside of the scope of tapering.

For tax year 2020/21 any carry forward available from 2017/18 needs to be used or it will be lost. In order to use it, contributions need to be made that, firstly, are enough to use up the current year’s annual allowance. Once the current year’s allowance has been used the rules ensure additional contributions then use the earliest carry forward year first.

As well as receiving tax relief at the client’s highest marginal rate there can be additional tax benefits of pension contributions for some clients as contributions can be used to reclaim the personal allowance where income exceeds £100,000, and avoid the high-income child benefit charge where income exceeds £50,000. The income definition used for both of these is “adjusted net income” and pension contributions will reduce this figure. Where contributions can restore allowances or avoid charges the effective rates of tax can be 60%, or more, making pension contributions even more attractive.

Finally, where a client has already maximised their reliefs, it is worth checking if there is any scope to make contributions for family members. Contributions will be limited by the recipient’s relevant UK earnings in the tax year they are paid or £3,600 if higher.