10 reasons to pay into your pension before April
The new pensions freedoms have removed any lingering barriers to accessing funds and passing on unused funds on death. Therefore, pensions remain most tax way to save for retirement and we have put together 10 reasons to fund pensions before 5 April.
1. Tax relief at highest rates
- Successive Chancellors have decided against cutting the rate of tax relief on pension saving. With the spotlight constantly falling on pension saving incentives, relief at the highest rates may not be around forever.
- Additional and higher rate taxpayers may wish to contribute an amount to maximise tax relief at 45%, 40% or even 60% while they have the opportunity. Carry forward can allow contributions in excess of the current annual allowance without any annual allowance tax charge.
2. Recover personal allowances
- Pension contributions reduce an individual’s taxable income, and are a great way to reinstate the personal allowance.
- For a higher rate taxpayer with taxable income of between £100,000 and £122,000, a personal contribution that reduces 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%.
3. Avoid the child benefit tax charge
- A personal contribution can ensure that the value of child benefit is preserved for the family, rather than being lost to the child benefit tax charge. It might be as simple as redirecting existing pension saving from the lower earning partner to the other.
- The child benefit, worth over £2,500 to a family with three children, 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 be avoided. 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 65% for a family with three children.
4. Sacrifice bonus for an employer pension contribution
- March and April is typically the time of year when many companies pay annual bonuses. Sacrificing a bonus for an employer pension contribution before the tax year end can bring several positive outcomes.
- The employer and employee National Insurance (NI) savings made could be used to boost pension funding, giving more in the pension pot for every £1 lost from take-home pay. The reduction in taxable income potentially means that lost personal allowance may be recovered, or the child benefit tax charge avoided.
5. Providing for loved ones
- The new death benefit rules will make pensions an extremely tax efficient way of passing on wealth to family members – there’s typically no Inheritance Tax (IHT) payable. There is also the possibility of passing on funds to any family members free of tax for deaths before age 75.
- Consideration could be given to moving savings which would otherwise be subject to IHT into pensions and shelter them from IHT and benefit from tax free investment returns. Provided they are not in serious ill-health at the time, any savings will be immediately outside the estate.
6. Dividend changes and business owners
- Many directors of small and medium sized companies may be facing an increased tax bill following changes to the taxation of dividends. A pension contribution could be the best way of cutting the overall tax bill, while still receiving the same level of income.
- If the director is over 55 they now have full unrestricted access to their pension savings.
- There is no NI on an employer pension contribution or dividend payment, but dividends are paid from profits after corporation tax AND may also be taxable in the director’s hands too. By making an employer pension contribution, this ensures that the tax that would have otherwise gone to HMRC boosts the director’s retirement savings instead.
7. Pay employer contributions before corporation tax relief drops
- Corporation tax rates are set to fall from 20% to 19% from the financial year starting April 2017 with a further planned cut to 17% to take effect from April 2020.
- Companies may want to consider bringing forward pension funding plans to benefit from tax relief at the higher rate. Payments should be made before the end of the current business year, while rates are at their highest.
8. Avoid the annual allowance cut for higher earners by using carry forward
- Some individuals with high income will face a cut in the amount of tax-efficient pension saving they can enjoy this tax year. The standard £40,000 Annual Allowance (AA) will be reduced by £1 for every £2 of ‘income’ individuals have over £150,000 in a tax year, until the allowance drops to £10,000.
- It may be possible to reinstate the full £40,000 allowance by making use of carry forward. The tapering of the annual allowance won’t normally apply if income less personal contributions is £110,000 or less. A large personal contribution using unused allowance from the previous 3 tax years can bring income below £110,000 and restore the full £40,000 allowance for 2016/17. Some of it may even attract 60% tax relief.
9. Last chance for a £50,000 carry forward
- Next tax year this will settle at £120,000, as all carry forward years will have a maximum allowance of £40,000.
- The maximum carry forward of unused allowances for the current year is £130,000, being £50,000 for 2013/14 plus £40,000 from 2014/15 and 2015/16.
- This tax year is the last opportunity to carry forward unused annual allowance from 2013/14 when it was still £50,000. If it isn’t used, the additional allowance will be lost and future carry forward limited to a maximum of £40,000 per year.
10. Boost SIPP funds now before accessing flexibility
- Anyone looking to take advantage of the new income flexibility for the first time may want to consider boosting their fund before April, potentially sweeping up the full £40,000 from this year plus any unused allowance carried forward from the last three years.
- The Money Purchase Annual Allowance (MPAA) will mean the opportunity to continue funding will be restricted. The MPAA is currently £10,000 but is set to fall to £4,000 a year in April – with no carry forward.
- However, anyone still in capped drawdown, or who only takes tax free cash via flexible drawdown, can access their pension pot and retain the full £40,000 allowance.
If you would like more information regarding any of the opportunities highlighted above, please contact us on:
01382 207060 or via firstname.lastname@example.org
Any reference to tax and legislation is based on our understanding of law and HM Revenue & Customs practice at the date of publication. Tax and legislation are liable to change. Tax relief may be altered and the value to the investor depends on their financial circumstances. The purpose of this article is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice. Investment entails risk which means the asset values can increase or decrease and you may not get back what you put in.
Henderson Loggie Financial Services is authorised and regulated by the Financial Conduct Authority.