There are several factors to take into account when contributing to a pension; how much you need to accumulate to meet your retirement goals, how much you can afford to pay in, and the most tax-efficient use of your allowances.
Investing into a pension offers significant tax advantages:
- Income tax relief is available on contributions;
- The funds grow in a tax efficient environment;
- 25% of funds can be taken tax free, currently from age 55 onwards (age 57 from 2028)
However, you should be aware that the tax advantages are limited.
- The annual allowance limits how much can be paid into a pension in a tax year.
- The lifetime allowance restricts the total value of benefits that can be held.
Annual Allowance
Whilst there is no limit to the amount of contributions that can be made each tax year, there are limits on the amount of contributions that can attract tax relief. This is known as the Annual Allowance. For individuals, the annual allowance is currently the greater of £3,600 gross or 100% of relevant UK earnings chargeable to income tax, subject to a maximum gross contribution of £40,000.
The standard annual allowance has been £40,000 since 2014/15. However, the annual allowance fell for high earners, with the introduction of the tapered annual allowance in the 2016/17 tax year.
- From 2021/22, Individuals who have adjusted income (income plus employer pension contributions) for a tax year of greater than £240,000 will have their annual allowance for that tax year restricted. It will be reduced, so that for every £2 of income over £240,000, their annual allowance is reduced by £1.
- The maximum reduction will be £36,000, so anyone with income of £312,000 or more will have an annual allowance of £4,000.
- The tapered reduction does not apply to anyone with threshold income (income less personal pension contributions) of no more than £200,000.
Carry forward allows any unused annual allowances in each of the three previous tax years to be added to the annual allowance or tapered annual allowance in the current tax year. The amount paid into or accrued in a pension in a tax year is known as the Pension Input Amount (PIA). Where the individual’s PIA in a tax year exceeds the annual allowance, together with any available carry forward, the excess will be taxed at the individual’s marginal rate(s) of income tax.
High income individuals caught by tapering may have to reduce the contributions paid by them and / or their employers or suffer an annual allowance charge.
Money Purchase Annual Allowance (MPAA)
If you’re over 55 and have already taken a taxable income from your pension, your annual allowance will be subject to the money purchase annual allowance (MPAA). This means your annual allowance for contributions into your pension would be reduced from £40,000 to £4,000 a year (2021/22 tax year).
The MPAA won’t be trigged if you solely take a tax-free cash lump sum but don’t take any income from your pension.
Lifetime Allowance
This is a limit to the amount you can build up in all of your pension plans over a lifetime without incurring a (or tax penalties) tax penalty.
The lifetime allowance for 2021/22 is £1,073,100. If you take any of your pension benefits and go over this limit, you may be subject to a lifetime allowance tax charge of up to 55%. It may be possible to keep a higher lifetime allowance if one of the forms of protection is applied for.
How tax relief works on pension contributions
When you save into your pension, you get tax relief from the government. This can help to boost your pension savings.
If you don’t understand pension tax relief, you’re not alone. 85% of UK adults say they don’t understand how tax relief works1
1 Source: Royal London and Opinium Pension Tax research, March 2021 – based on 2000 UK adults surveyed
Whilst an individual can make unlimited contributions to a UK registered pension, tax relief is only available to individuals who have not attained age 75 and is limited to contributions not exceeding the greater of 100% of relevant UK earnings and £3,600 gross (£2,880 net).
There is no restriction on the maximum pension contribution that can be paid by an employer to an individual’s pension plan. The employer’s entitlement to tax relief will only be granted on that part of the contribution that is deemed by HMRC to have been paid ‘wholly and exclusively’ for the purposes of the trade. If there are any doubts then it is best to refer to your accountant or tax adviser.
How does it work?
If you’re a basic rate taxpayer you can contribute £100 into your pension for just £80. This means when you personally pay into your pension, you’ll get a boost from the government in the form of tax relief. The more you pay into your pension, the more help you’ll get.
For example, if you pay basic rate tax:
| You pay | Tax relief added as a boost to your contribution | Total contribution added to your pension plan |
| £80 | £20 | £100 |
| £160 | £40 | £200 |
| £240 | £60 | £300 |
If you pay a higher or additional rate of income tax you could benefit from additional tax relief which you can claim from HM Revenue & Customs. Tax relief can change and depends on your individual circumstances and where you live in the UK.
To discuss how we could help put in place a sufficient retirement planning strategy to meet your retirement income requirements, please contact us for more information.
The information provided is for general information only and is not intended to address the particular requirements of an individual. It does not constitute any form of advice or recommendation by Menzies Wealth Management Ltd and should not be relied upon by individuals in either making or refraining from making any investment decisions. Where necessary, you should seek appropriate professional advice before acting on any of the information provided. Different investments carry different risks. Past performance is not necessarily a guide to future performance and the value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invested.
Menzies Wealth Management is authorised and regulated by the Financial Conduct Authority (486548). Registered address: 1st Floor, Midas House, 62 Goldsworth Road, Woking, GU21 6LQ Registered in England and Wales 06597008.
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