As the tax year end approaches, I’ve identified 10 good reasons to pay into a pension in this tax year. Will any of these strike a chord with you? I should note here that because pensions and tax can both be pretty complex, I have included quite a lot of detail here. If you want to investigate any of these tips further, you should take advice before you make any decisions about your finances.
Tax relief and a tax free growth environment are powerful incentives to make a pension contribution at any time. Higher rate taxpayers using their full £50,000 pension annual allowance can convert a £20,000 tax bill into their own retirement savings.
The good thing about the tips that follow are that they are all based on what we know, not speculation about what might happen in the future.
1. Get 50% tax relief while you can
- The highest rate of income tax drops from 50% to 45% from April 2013. So wealthier people can gain an extra 5% relief by paying in to pensions this tax year. An additional rate taxpayer could save an extra £5,000 on their tax bill this year if they had scope to pay £100,000. And flexing the carry forward and Pension Input Period (PIP) rules gives scope to pay up to £250,000 tax efficiently this tax year.
- But it’s a good idea not to over-egg the pudding. Once a pension payment takes your income below the £150,000 additional rate threshold, relief on the balance drops to 40%. So, in some cases, it’ll make sense to consider deferring part of a large payment until the new tax year so it gets 45% relief rather than 40%.
2. Pay employer contributions before corporation tax relief drops
- Corporation tax rates are falling. So business owners may want to consider bringing forward pension funding plans to benefit from tax relief at the higher rates. Payments should be made before the end of the current business year, while rates are at their highest.
- For the current financial year the main rate is 24%. This drops to 23% for the new financial year starting 1st April 2013 and is expected to be at 21% the following year.
3. Sweep-up unused allowances from 2009/10
- The clock is ticking. Unused pension annual allowance from 2009/10 must be used in this tax year – or it’s lost forever. If you’re a 40% taxpayer, for example, this could mean a missed opportunity to save up to £50,000 at a net cost of only £30,000.
- The annual allowance is tested against contributions made in the PIP rather than the tax year. People already in their 2013/14 PIP, who still have unused allowance from 2009/10, could start a new contract to sweep this up. A new contract started this tax year automatically has a PIP ending on 5th April 2013 i.e. in the 2012/13 tax year.
- And the transitional provisions for 2011/12 PIPs that started before 14th October 2010 mean some people may have more carry forward available than may appear on the surface. They could still have carry forward from earlier years despite having paid up to £255,000 for 2011/12.
4. Make the most of the £50,000 pension allowance
- The annual allowance drops to £40,000 from tax year 2014/15. But the PIP rules mean it hits some people from April this year.
- Carry forward for the 3 previous years back to 2010/11 will still be based on a £50,000 allowance. But over time, the new £40,000 allowance will come into the calculation and dilute what can be paid. Up to £200,000 can be paid to pensions for this tax year without triggering an annual allowance tax charge. By 2017/18, this will drop to £160,000 – if the allowance stays at £40,000. And you can’t ignore the risk of further cuts.
5. Use next year’s allowance now
- Some people may want to pay more than their 2012/13 allowance – even after using up all their unused allowance from the 3 carry forward years. To get round this, they can pay against their 2013/14 before 6th April by closing their 2012/13 PIP early. This opens up their 2013/14 PIP – allowing an extra £50,000 to be paid in this tax year.
- This might be worth considering for someone with particularly high income for 2012/13 who wants to make the biggest contribution they can with 50% tax relief. Or perhaps a company who has had a particularly good year and wants to reward directors and senior employees and reduce their corporation tax bill.
6. Recover personal allowances
- Pension contributions reduce an individual’s taxable income. So they can be a great way to reinstate the personal allowance and the age related element of personal allowance.
- Personal allowance. If you’re a higher rate taxpayer with taxable income of between £100,000 and £116,210, an individual contribution that reduces your taxable income to £100,000 would achieve an effective rate of tax relief at 60%. For higher incomes, or larger contributions, the effective rate will fall somewhere between 40% and 60%.
- Age related element of personal allowance. For someone between the age of 65 and 74, a pension contribution reducing taxable income to below £25,400 will reinstate the age related element of the personal allowance. The full amount of the age related element is £2,395 in 2012/13 – saving £479. But allowance is wiped out once income exceeds £30,190.
7. Equalise the child benefit tax charge using pension contributions
- An individual pension contribution can ensure that the value of child benefit is saved for the family, rather than being lost to the new child benefit tax charge. And it might be as simple as redirecting existing pension saving from the lower earning partner to the other.
- The child benefit, worth £2,449 to a family with 3 kids, is cancelled out by the tax charge if the taxable income of the highest earner exceeds £60,000. There is no tax charge if the highest earner has income of £50,000 or less. As a pension contribution reduces income for this purpose, the tax charge can thus be minimised. The combination of higher rate tax relief on the contribution plus the child benefit tax charge saved can lead to effective rates of tax relief as high as 64% for our family with 3 children.
8. Sacrifice bonus for employer pension contribution
- It’s bonus season again. Sacrificing bonus for an employer pension contribution before the tax year end could bring several positive outcomes.
- The employer and employee NI savings made could be used to supercharge pension funding, giving more in the pension pot for every £1 lost from take-home pay. And your taxable income is reduced, potentially recovering personal allowance or reducing the child benefit tax charge.
9. Boost SIPP funds now before moving to flexible drawdown
- If you are considering a move to flexible drawdown in the new tax year, the remainder of this tax year is the last opportunity to make tax efficient pension savings.
- Remember, no pension contributions can be made in the year flexible drawdown starts. And contributions in the tax years after starting flexible drawdown all suffer the annual allowance tax charge.
10. Fund and protect above the new £1.25m Life Time Allowance (LTA) limit
- With the lifetime allowance set to fall to £1.25m from April 2014, there will be some people now weighing-up the pros and cons of electing for the new ‘fixed protection 2014’ to lock into a £1.5m LTA. But they’ll have to stop paying into pensions after 5th April 2014. So this only leaves a short window to maximise tax efficient contributions and build a bigger retirement pot to protect.
- There may be a second choice of protection, known as ‘personalised protection’, which would give an LTA between £1.25m and £1.5m and allow further pension savings to be made. But this isn’t certain. And we won’t know the details until late March at best. It’s usually best to work with the rules you know.
Laws and tax rules may change in the future. The information here is based on our understanding in March 2013. Your personal circumstances also have an impact on tax treatment. Remember as with any investment the value of your fund can go up or down and may be worth less than what was paid in.
What’s your view?
Do you make the most of tax allowances the government provides?
Check out our guide to being more tax efficient
Understand more about tax allowances from HM Revenue and Customes