Pensions - Articles - Pension savers told to claim tax relief while they still can

 Gary Smith, Partner in Financial Planning and retirement specialist at leading UK wealth manager Evelyn Partners, says today’s savers can’t be too relaxed and assume that they will always have the opportunity to top up their pensions with the bonus of relief at their highest rate of tax:

 “This year, taking advantage of pension tax relief is perhaps more important than ever. Not only is the growing tax burden eroding incomes and wealth but also we will have a General Election this year and who knows what could happen to pension tax relief and the annual allowance under a new government.

 “Higher and additional rate pension tax relief is the cat with nine lives when it comes to tax reform drives by successive Chancellors looking to raise extra revenues. It has come under the Treasury spotlight regularly over the last decade or more, usually around Budget time, and escaped unharmed – to the relief (pun intended) of many of the UK’s pension savers.

 “The annual allowance for pension contributions is not ‘use-it-or-lose-it’ in quite the same way as the ISA allowance or CGT exemption, as the option to claim previous years’ unused allowances does exist under ‘carry forward’ rules. But political and budgetary imperatives could coincide over the next few years to water down generous pension benefits. There’s absolutely no guarantee that this valuable personal tax relief or the higher annual allowance will be around forever.

 “Before ploughing more money into a pension, everyone should reflect on whether they can afford to lock away the funds until private pension access age, and whether making extra contributions makes sense in the context of their overall financial situation.

 But with personal tax allowances frozen, and almost everyone paying more in tax as each year goes by, pension saving is one of the few ways of mitigating fiscal drag and keeping more of one’s earned income.

 “So the higher rates of pension tax relief might be viewed on a ‘grab it while you can’ basis by those who have a bit of slack in their monthly budget or a lump sum in a bank account that could be working harder.

 “For many of the more than 20million employees participating in workplace pensions, this could be simply a case of going into their HR or pension portal and raising their percentage monthly contribution. With the recent boost from the 2% cut in National Insurance, now would be a good time, as pension contributions could be nudged up without a change in take-home pay.

 “Even if you are wondering whether investment returns will beat the 5% that some deposit accounts are currently paying, that is almost irrelevant when you factor in the tax relief turbo-charge that’s unique to pension savings. In any case, the 5% available on a few savings accounts looks set to be short-lived with rate cuts on the horizon, and if history is anything to go by, then you won’t have to take high levels of risk to beat that with long-term investing within a pension, never mind tax relief.”

 Smith adds that working out how much of the 2023/24 allowance one has used up, considering whether and how to use up the remainder and deciding whether to boost pension contributions even further by using some ‘carry forward allowances’, is a job best not left to the last minute:

 “While 5 April might feel like a way off, working out these pension reckonings is a process that savers can start now so that it’s not a panic finalising arrangements before the tax year closes.”

 The annual allowance

 Smith says: “As for the annual allowance, when it was raised from £40,000 to £60,000 at the March 2023 Budget, Labour suggested that they would look at reversing Jeremy Hunt’s measures, which also included the abolition of the Lifetime Allowance, a step that hits the statute books in April.”

 The AA puts a cap on how much can be saved into a pension each year with tax relief benefits. It means that in the current tax year and the 2024/25 tax year (as things stand) savers can put £60,000 into a pension while still benefiting from pension tax relief. That amount is gross contributions, or the total put into a pension, so includes employer top-ups and the tax relief itself.

 Anyone earning less than £60,000 a year is limited by an allowance for personal contributions instead equal to the total of their earnings in that year – but employer contributions can be made on top of this. More than the AA can be saved into a pension annually, but the contributions will not benefit from tax relief, and if the AA is exceeded, inadvertently or otherwise, savers might be faced with an unwelcome or unexpected bill from HMRC when tax relief is clawed back.

 The highest earners, however, face a disadvantage in the tax relief stakes in the form of the tapered annual allowance, which affects those with a ‘threshold income’ of more than £200,000.[1] They see their AA reduce by £1 for every £2 they exceed an ‘adjusted income’ of £260,000. This taper brings the AA down to a minimum of £10,000. In other words, those earning £360,000 and above can put only £10,000 a year into a pension while still benefiting from tax relief.

 Smith says: “Many of those looking to benefit from the demise of the Lifetime Allowance and resume or increase pension contributions beyond the £1million mark will be hobbled by this restriction.

 “Whatever your AA, the opportunity arises at this time of year to tot up monthly pension contributions – including those due to be made before the end of the tax year – plus any bonuses paid into pension, and work out if there is any AA left.[2] There could be many worse ways to use some idle cash than to mop up that remaining AA.”

 Carry forward allowances and lump sum contributions Those who are set to maximise their current year’s allowance can also mop up any unutilised annual allowances for the three previous years thanks to carry-forward rules.

 Smith says: “Note that the annual allowance was £40,000 until the current tax year. Still, that affords a maximum of £180,000 that can be paid into a pension in this tax year for those entitled to four years of the full AA, and whose earnings allow it. But there are some rules and restrictions to note when considering carrying forward.”

 You must have first used up the current year’s allowance – so the first step is to get an accurate reading of this year’s contributions and take those to the limit.

 To get tax relief on pension contributions that you make yourself, you need to ensure that the payments made in any tax year do not exceed earnings in that year. An employer is not restricted by an individual’s earnings so they are able to pay in higher sums on occasion.

 You will need to have had a pension in each of the three previous tax years but you don’t need to have made any contributions and your new contributions do not have to be made into the same pension.

 Allowances from the ‘oldest year’ are used up first and at the end of every tax year, the oldest year falls away. Therefore, any allowances not used from the oldest year – now 2020/21 - will be lost for good if they are not carried forward.

 Savers who have a lump sum via a windfall like an inheritance might be looking to boost their pension by using up carry forward allowances before 5 April but an important limitation on this is the second rule above – their ‘relevant earnings’ in this tax year.[3]

 This is because, even if they have available allowances to the potential tune of £180,000, the amount they can put into their pension is still limited by their earnings in the tax year that they make the lump sum injection.

 Business owners with irregular earnings who receive a glut of revenue all at once often find carry forward a very useful pension-boosting tool.

 “Due to annual allowance rules business owners who have control over payments and remuneration can also opt for the business to make employer contributions into their pensions to maximise carry forward even if their relevant earnings in that year are much lower. However, as threshold income includes employer contributions, they need to be careful of tapering rules if this exceeds £200,000.”

 Smith adds: “The ability to carry forward can be extremely useful for those looking to catch up on pension contributions because they want to give their pot a late boost before retirement, or because their financial position has improved and they want to take advantage of the tax reliefs on offer.

 “Anyone over 50 years who receives a lump sum that they do not immediately need might consider ploughing it into their pension via carry forward as it will not be long before they can access a chunk of those savings tax-free anyway under pension freedom rules. The normal minimum pension age at which savings can be accessed is currently 55, rising to 57 from April 2028.

 “It can be useful for those restricted by the tapered AA, especially if their earnings have suddenly increased and in previous years were below the threshold for the tapered allowance.

 “But those who choose not to use up each year’s annual allowance as it arises should be wary of relying on carry forward too much, by assuming they can make up contributions at a later date. A bit like pensions tax relief itself, we don’t know how long carry forward will be around for.”

 Where to put extra contributions

 Those still paying into a workplace pension might wonder how to go about making one-off contributions as their monthly contributions are typically handled automatically by payroll and most employers give the option of feeding annual bonuses directly into the workplace scheme.

 Smith says: “Employees looking to make one-off lump sum contributions can usually do so into their workplace scheme but others might choose to do so by opening a SIPP. This could offer flexibility when it comes to access: for instance a saver who wants to draw their tax-free lump sum but continue to pay into their workplace scheme, could take the lump sum from their SIPP. That leaves the workplace scheme undisturbed.”

 Claiming back higher and additional rate tax relief

 Smith says: “In many sorts of pension, the saver receives only the basic rate relief uplift immediately and automatically. Those paying into a personal pension like a stakeholder plan or SIPP will be used to having to claim their higher or additional tax relief via self-assessment.

 “Or at least one would hope so, as recent evidence suggests that a huge amount of pension tax relief is going unclaimed. In the case of self-administered personal pensions, this very expensive oversight could be a case of forgetfulness as much as ignorance.

 “However, many workplace scheme savers might be unaware of how their contributions work and that they also might need to reclaim relief from the higher tax rates. While ‘net pay’ and salary sacrifice schemes bestow tax relief at the marginal rate through payroll at the point of contribution, workplace pensions run on the confusingly named ‘relief at source’ basis do not, and those entitled to higher or additional rate tax relief must claim it back via a tax return.”

 Smith concludes: “Questions around tax relief and carry forward can get very confusing and it’s always best to seek advice from a financial planner in these matters. Where a pension saver has, or is likely to have, hundreds of thousands of pounds saved, there will be crucial decisions to be made - in terms of both tax efficiency and portfolio management, and in both the saving and the access phases - that will benefit hugely from professional advice.”