Pension Allowances and Tax Relief
Saving into a pension is one of the most tax-efficient ways to save for your retirement. Not only do pensions enable you to grow your retirement savings largely free of tax, but they also provide tax relief on the contributions you make.
There are limits on the amount you can invest in pension plans and on the maximum value of pension savings that you can build up without being subject to a tax charge.
These limits are known as the Annual Allowance and the Lifetime Allowance.
The contributions you make in a tax year count towards the annual allowance for that tax year.
The government has set a limit on the amount of pension contributions you can make each year before you are taxed. This is called the annual allowance.
The annual allowance for tax year 2021/2022 is £40,000, which means you could contribute £40,000 before a tax charge may apply.
If, however, you have taxable income for a tax year greater than £240,000, you will have your annual allowance for that tax year restricted.
This means that for every £2 of income you have over £240,000, your annual allowance is reduced by £1.
If you have already taken some of your pension savings, your future pension contribution limit may be restricted to the money purchase annual allowance.
Money Purchase Annual Allowance
The Money Purchase Annual Allowance (MPAA) rules were introduced as an anti-avoidance measure to prevent wide-spread abuse of the pension freedoms which commenced from 6 April 2015. It is intended to discourage individuals from diverting their salary into their pension with tax relief and then immediately withdrawing 25% tax-free.
How does it work?
If you choose to access your retirement savings flexibly, certain payments will trigger the MPAA. This means your annual allowance for contributions into defined contribution arrangements would be reduced from £40,000 to £4,000 a year.
What triggers the MPAA?
- If you choose to take an income from a flexi-access drawdown plan set up from 6 April 2015.
- Taking a full or partial cash lump sum withdrawal from your plan.
- Taking an income above the maximum limit from an existing capped drawdown plan.
The MPAA applies only to money purchase contributions and has remained at £4,000 since 6 April 2017.
All your pensions, including workplace pensions, count towards the Lifetime Allowance, except for the State Pension and overseas pensions. The standard Lifetime Allowance is £1,073,100 for the current tax year and is due to increase with inflation each year.
You do not pay the tax charge until you take your pension savings over and above your Lifetime Allowance (or reach age 75, if earlier). The charge is only on the excess money saved in your pension that is above your Lifetime Allowance
Pension tax relief
The taxman encourages pension saving by giving tax incentives, commonly known as tax relief. Tax relief is restricted to the higher of £3,600 or 100% of your earnings.
Each time you save into your pension plan, you will receive tax relief from the taxman, boosting your retirement savings.
- Basic rate tax relief is 20% therefore if you pay £80 into your pension the taxman will pay £20 so the overall contribution will be £100.
- Higher rate taxpayers tax relief is 40% so a contribution of £100 costs them £60.
- Additional rate taxpayers can claim 45% tax relief so a £100 contribution costs them £55.
Tax relief is not added to any contributions made to your pension by your employer.
Non-taxpayer or earning less than £3,600
If you have no earnings or earn less than £3,600 a year, you can still pay into a pension scheme and qualify to receive tax relief added to your contributions up to a certain amount.
The maximum you can contribute is £2,880 a year. Tax relief is added to your contributions, so if you pay £2,880.
A total of £3,600 a year will be paid into your pension scheme, even if you earn less than this or have no income at all
Tax rules depend on your individual circumstances and could change in the future.
Seek Professional Advice
The world of pensions can be complex and there are many rules especially if you have older plans. Getting it wrong could cost you £1000’s in fees, charges or loss of fund values.
I have been providing pension advice to my clients for nearly 30 years and if you haven’t reviewed your pensions for a while now might be an ideal time to do this.
For an initial discussion about your pensions – please get in touch.
You can contact the office on 01564 732770 or use the links below.