Pension planning; an opportune time to review your current level of pension funding?
For a number of years, high earners have seen significant restrictions on the amount they can contribute to a pension. For those earning over £210,000, contributions have been limited to £10,000 per year, forcing them to look at other options when saving for later life. However, the March budget brought a reprieve. Where possible, high earners should seize the opportunity to make additional pension contributions.
Since 2016, the annual contribution for pensions has tapered away for those with earnings of £150,000, with savers losing £1 of allowance for every £2 of additional income up to £210,000. In the budget, the lower limit was lifted by £90,000, so tapering starts at £240,000. The move was ostensibly to protect NHS doctors, who were cutting back on overtime to reduce the hefty tax charges they were facing by exceeding this limit. However, the government made the changes applicable across all professions.
However, there was a notable downside. At an income level of £312,000 and above, you will only be able to make contributions of £4,000 gross a year, a far more stringent restriction than before. As before, any contributions in excess of this amount are taxed at your highest marginal rate. This will leave many top earners looking at other options to save tax efficiently towards retirement.
The new rules will allow many people to significantly increase their contributions. Equally, it may be that ordinarily you are a high earner with income above £312,000, but you are now facing cuts in salary, dividends or investment income as a result of the Covid-19 outbreak. It could be that for the current tax year, you find yourself below the limit. This should prompt a review of your pensions and savings to see if there is scope to take advantage of the higher and additional tax relief available.
It's important to take advantage while you can. Your salary and bonus may not stay low indefinitely and, if recent history is a guide, the tax rules may change once again. Potential changes to higher rate tax relief are mooted in every budget and the Chancellor will have a significant hole to fill once he has finished paying for the Covid-19 outbreak.
For those keen to make additional contributions not affected by the taper, the standard annual allowance remains at £40,000 (while the money purchase annual allowance – for those already drawing on their pension - remains at £4,000) and you can invest up to the full amount across workplace and personal pensions. Any contributions should be in line with your overall risk objectives and investment strategy. We can help you weigh up your options.
One caveat is that it is worth taking the lifetime allowance into account. It rose to £1,073,100 in the March budget, increasing by CPI. While this looks high, those aged 45 sitting on pension savings of £300,000 and continuing to make relatively modest contributions of £1,000 per month would hit the limit within 20 years (assuming investment growth of 5%). Pension valuations in excess of the lifetime allowance are taxed at different rates depending on how you opt to take those benefits, so it is important to take advice on the most tax efficient option.
For those in defined benefit or final salary schemes who are still affected, it is worth investigating whether the scheme will consider paying any tax charge through the ‘voluntary scheme pays’ option. This is where the scheme pays the tax rather than the individual.
The alternative is pay the tax charge personally. This is a complex area and specialist advice should be taken to determine the financial trade-off between loss of guaranteed pension income in retirement and loss of capital today. The right option will depend on your circumstances.
For most people the new rules will be a welcome opportunity to make higher pension contributions. With tax relief under constant review, it is usually worth taking advantage. For those above the higher earnings threshold, a rethink may be needed. There are options, but some advice may be worthwhile.
Government and tax legislation is that prevailing at the time, is subject to change without notice and depends on individual circumstances. Clients should always seek appropriate advice from their financial adviser before making financial decisions. May 2020, Gov.uk.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of publication.
Smith & Williamson Fund Administration Limited is authorised and regulated by the Financial Conduct Authority.