UNDERSTANDING HOW TO MAKE THE MOST OF THEM
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 various pension allowances in place that you need to be aware of and understand how to make the most of them. These limit the amount of money you can contribute to a pension in a year, as well as the total amount of money you can build up in your pension accounts, while still enjoying the full tax benefits.
PENSION LIFETIME ALLOWANCE
All your pensions, including workplace pensions, count towards the pension Lifetime Allowance (LTA), with the exception of the State Pension and most overseas pensions. The standard pension LTA for the 2022/23 tax year £1,073,100. You don’t pay the tax charge until you take your pension savings over and above your pension LTA (or reach age 75, or on death before 75, if earlier). The charge is only on the excess money saved in your pension that is above your pension
LTA. 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.
This applies if you pay into a personal or stakeholder pension yourself (so not through an employer’s scheme) and with some workplace pension schemes – but not all. The way some workplace pension schemes give tax relief means that people earning less than the personal allowance (£12,570 in the 2022/23 tax year) won’t receive tax relief. This is the same as in 2021/22. In the March 2021 Budget, Chancellor Rishi Sunak said the personal allowance – along with several other tax allowances – would be frozen until 2026.
MONEY PURCHASE ANNUAL ALLOWANCE
The Money Purchase Annual Allowance (MPAA) rules were introduced as an anti-avoidance measure to prevent widespread abuse of the pension freedoms, which commenced from 6 April 2015. It’s intended to discourage individuals from diverting their salary into their pension with tax relief and then immediately withdrawing 25% tax-free. The MPAA applies only to money purchase contributions and has remained at £4,000 since 6 April 2017.
If you have taken flexible benefits which include income, such as an ‘Uncrystallised Funds Pension Lump Sum (UFPLS)’ or flex access drawdown with income, and you want to continue making contributions to a defined contribution pension scheme, you will have a reduced annual allowance of £4,000 towards your defined contribution (money purchase) pension benefits.
The pension Annual Allowance (AA) is the maximum amount of money you can contribute towards a defined contribution pension scheme in a single tax year without suffering an additional tax charge. All contributions made to your pension by you, your employer or any third-party, as well as any tax relief received, count towards your AA. The standard pension AA in the tax year 2022/23 is £40,000. A lower AA may apply, however, if you are a high earner or you have already started accessing your pension flexibly. High earners may potentially be subject to the Tapered Annual Allowance, while those who have already started accessing their pension flexibly will be subject to the Money Purchase Annual Allowance (MPAA).
Carry forward is a way of increasing your pension Annual Allowance (AA) in the current tax year. It is used when your total pension contribution amounts for a tax year exceed your annual pension AA limit for that year. Carry forward allows you to make use of any annual allowance that you might not have used during the three previous tax years, provided that you were a member of a registered pension scheme during the relevant time period. If the total contributions to your pension in an individual tax year are more than your total Annual Allowance, including any unused pension AA from previous tax years, then you’ll have to pay an annual allowance charge.
THE STANDARD PENSION AA IN THE TAX YEAR 2022/23 IS £40,000. A LOWER AA MAY APPLY, HOWEVER, IF YOU ARE A HIGH EARNER OR YOU HAVE ALREADY STARTED ACCESSING YOUR PENSION FLEXIBLY.
TAPERED ANNUAL ALLOWANCE
The Tapered Annual Allowance, or pension Annual Allowance, is the annual limit on the amount of contributions paid to, or benefits accrued in, a pension scheme before the member has to pay tax. The Tapered Annual Allowance is lower than the standard Annual Allowance. Since 6 April 2020, it will only affect people who meet both of the following income requirements: your ‘threshold income’ is above £200,000, and your ‘adjusted income’ is above £240,000. Anyone who meets the income requirements above will see their Annual Allowance gradually reduce by £1 for every £2 of ‘adjusted income’ above £240,000. For example, if your adjusted income was £280,000 your annual allowance would be reduced to £20,000. This ‘tapering’ stops at £312,000 of adjusted income, so everyone will retain an allowance of at least £4,000.
PENSION TAX RELIEF
The government encourages you to save for your retirement by giving you tax relief on pension contributions. Tax relief has the effect of reducing your tax bill and/or increasing your pension fund. You can receive tax relief on your own pension contributions worth up to 100% of your annual earnings or £3,600 if more. Since the tax relief you receive on your pension contributions is paid at up to the highest rate of Income Tax you pay, the higher your rate of tax, the more you could receive. The Welsh Government now has the power to set Income Tax rates and bands, but has opted to keep these the same as England and Northern Ireland for tax year 2022/23. If you live in Scotland, you pay Scottish Income Tax to the Scottish Government and for earned and pension income the tax rates and bands are different to the rest of the UK (but the same as the rest of the UK for savings and dividend income)