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Save as much as you can in your Pension BUT get the limits right

Roddy Kohn explains how you can maximise your clients’ pension pots by utilising the tax reliefs on offer

Did you know you can contribute as much as you like to your pension fund each year? Yes, you really can. However, there are restrictions on the amount of tax relief that you will receive on those contributions.

So how much of your contribution will receive tax relief? Well, tax relief is restricted to gross contributions of £3,600 or 100% of your relevant earnings up to the annual allowance, which is currently £40,000 gross.

Let’s put this into plain English. Relevant earnings are essentially any earnings that are subject to income tax; however, pension income, rental income and dividends are not classed as relevant income. If you don’t earn any income, you can put £3,600 gross into a pension. In reality you would make a net contribution of £2,880 while your pension provider would claim the 20% tax that you have paid. If you have relevant earnings in a tax year of £40,000 or more, you could make a maximum gross pension contribution of £40,000 in that tax year.

Employer pension contributions have no restrictions; however, the payment may not receive tax relief on the whole amount. Also, the £40,000 limit includes both member and employer contributions, and therefore if this limit is breached the excess will be taxed at your marginal rate of tax.

In calculating your annual allowance you need to make sure you not only take into account contributions you make to a personal pension but you also have to take into account the ‘deemed’ contribution in your final salary scheme.

If you’re putting money into a personal pension it’s easy to calculate how much you have contributed to your pension. But what if you are a member of your final salary (defined benefit) scheme? How do you calculate your contributions? Well, it’s not as simple as looking at your payslip and adding up your contributions. The calculation is slightly more complex as it is based on the increase in value of your rights during the tax year.

Carry forward of unused relief

Carry forward allows you to use unused annual allowance from the three previous tax years. There are a couple of caveats: you would have had to be a member of a pension scheme in the year you are carrying forward but you needn’t have contributed in that year. Also, to claim tax relief on the whole amount you would need to have relevant earnings of at least the same amount as your pension contribution.

If your employer is making the contribution this does not apply. So your employer could put up to £160,000 into your pension fund in the current tax year without breaching the limits. However, if you were making member contributions and wanted tax relief on all of your contribution you would not be able to make a contribution of £160,000. Why? Because in order to get tax relief on £160,000 you would need relevant income of at least £160,000. However, if you have ‘adjusted’ income over £150,000 your contributions are restricted by the tapered annual allowance.

Tapered annual allowance

You’ve probably gathered from above that HMRC don’t like to keep things simple. So to determine whether you are affected by the tapered annual allowance you need to understand the difference between adjusted and threshold incomes.

Both definitions include all taxable income. Unlike ‘relevant’ earnings, both of these include all investment income as well as benefits in kind. The difference between the two is that adjusted income includes all pension contributions (including employer contributions), while threshold income excludes all pension contributions.

You would only be affected by the tapered annual allowance if your adjusted income is greater than £150,000 and your threshold income is over £110,000. If you are affected it means that for every £2 of income over £150,000 your allowance is reduced by £1. The maximum reduction is £30,000 and therefore your annual allowance would be £10,000 for anyone with an adjusted income of £210,000 or more.

Example: Let’s assume you have employed income of £165,000, rental income of £15,000, your employer makes a £20,000 contribution to your pension and you make a personal pension contribution of £10,000.

Threshold income

• Deduct your member pension contribution.

• Therefore £165,000 + £15,000 – £10,000 = £170,000

Adjusted income

• Your adjusted income would be £165,000 + £15,000 + £20,000 = £200,000.

• The reduction to your pension allowance would be £200,000 – £150,000/2 = £25,000

• The annual allowance will therefore be reduced to (£40,000 – £25,000) = £15,000.

As both threshold and adjusted incomes are above their minimum requirements, the annual allowance would be reduced.

In this scenario, the reduced allowance is £15,000 and would therefore face an annual allowance tax charge on £15,000 (employer contribution + member contribution – tapered allowance). The tax charge will be your marginal rate of tax unless you can carry forward unused allowance from a previous year.

So there you have it. I hope you’ve enjoyed all of the technical information. However, while it is very handy to know the rules, equal if not greater importance must be given to your pension’s investment strategy. Ensuring your portfolio is tailored to your own particular circumstances with respect to risk is vital to ensure you will be able to enjoy the retirement that you crave. Therefore, if you are not well versed with investment strategies and portfolio diversification, I urge you to seek advice.

• Roddy Kohn is Managing Partner at award-winning wealth managers KohnCougar (Roddy@kohncougar.co.uk)

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