Written by Ray Coman
|Minimum Annual Allowance||£4,000||£10,000|
|Adjusted Income Threshold||£240,000||£150,000|
A Up to the lower of 100% of earnings or the maximum contribution. Maximum contribution is the annual allowance plus unutilised allowances from the three previous tax years. Up to £3,600 may be contributed, irrespective of earnings. Annual allowance reduced by £1 for every £2 income over £240,000 to a minimum of £4,000. More information can be found here on the pension allowance.
There are various tax incentives for contributing to a pension, designed to encourage people to make adequate retirement provision.
Many types of payments made by an employer for the benefit of an employee are subject to taxation. However, employer pension contributions are not treated as a taxable benefit.
Employer contributions can be deducted from corporation tax profits, in the accounting period in which they are paid. For large organisations, corporation tax relief is sometimes spread over different accounting periods.
As employee contributions are not deducted from pay subject to national insurance, it is more tax efficient for a one person company to make contributions as an employer.
Up to the age of 75, a person can pay up to 100% of taxable income into a pension and obtain tax relief on these contributions. This is subject to the annual allowance, which is explained in more detail in the following section. In effect, the amount of income subject to tax is reduced by any pension contributions made by that person. In practice, HMRC will pay to the pension provider 20% of the amount that the taxpayer contributes. For higher rate taxpayers a further 20% tax relief is available.
An individual who does not pay tax, for instance with taxable income less than the personal allowance, can invest up to £2,880 a year and HMRC will pay a further 20% to the pension provider.
An individual can also obtain tax relief on pension contributions made on their behalf by someone else (such as a family member.) Further guidance is available on pension contributions made to a spouse via a one person company.
There are no limits on the amount that an individual can contribute to a pension. However, only contributions up to the annual allowance, above, will qualify for tax relief. Both employer contributions and employee contributions are taken into account when measuring whether the annual allowance has been exceeded for a tax year. For this purpose, employee contributions are taken gross, i.e. including any tax paid by HMRC to the pension provider.
A person can carry forward any unused allowance for any of the previous three tax years.
Contributions made in excess of the annual allowance are subject to a charge, as stated in the table above. The excess is added to other income for the year and treated as the 'top slice' of income. The income will therefore be taxed according to the income tax band effective for the tax year.
There is no charge in the year that a pension holder dies or starts to receive pension benefits following a retirement on the grounds of ill-health.
From 6 April 2016, the annual allowance will be tapered for taxpayers with total income of over £240,000. For every £2 that income exceeds £240,000, £1 of annual allowance will be reduced. The abatement cannot reduce the annual allowance below a limit of £4,000.
Annual allowance is similarly tapered for taxpayers with net income of over £240,000. The net income is after deduction of both employee and employer pension contributions. To clarify, if no contributions are made the abatmenet threshold is Adjusted Income Threshold of £240,000. However, the abatment threshold could start at Income Threshold to the extent that adjusted Income threshold has been reduced by pension contributions. In practice the lower threshold is often P60 less employer contributions.
Unused brought forward allowance can still be used, even where the current year allowance has been abated.
Under an occupational scheme, pension contributions are usually deducted from gross pay. It is employment earnings after deduction of pension contributions which are subject to tax. However, this is not always the case, and some employers deduct pension contributions from pay after tax.
Where a pension contribution is made from net pay, the equivalent basic rate tax is paid by HMRC direct to the approved pension provider. Consequently, at the rate effective 2014/15, for every £80 of take home pay a person contributes, HMRC pays £20. To the extent that a person is a higher rate taxpayer, the additional 20% tax relief is provided by extending the basic rate band. In practice, higher rate tax relief is obtained by altering the PAYE code to reduce tax at source, or via a Tax Return.
Contributions to a non-UK scheme will enjoy the same tax benefits provided there is a double taxation agreement in place with the country in which the pension is administered.
The lifetime allowance is the value of a pension which will be free of tax. In general, any income or gains from assets held in an approved pension scheme are exempt from tax. However, once a pension exceeds a certain value, a potential tax liability arises on the excess. The value of the pension is assessed against the lifetime allowance on benefit crystallisation event. Most commonly, this event is the earlier of the date that:
- The member is entitled to enjoy benefits.
- The member reaches 75 years of age.
- The pension is used to pay a lump sum in the event of the death or serious ill health of its member.
On the date that a pension vests, any excess of the pension value over the lifetime allowance is subject to a charge of 55% for amounts paid as a lump sum, and 25% for amounts paid as a pension.
Along with the state pension, the lifetime allowance increased in line with Consumer Price Index. The lifetime allowance for 2020-21 has therefore increased to £1,073,000. The income limit adjusted income limit and minimum pension allowance all change from 6 April 2020 as announced in the Budget.
A member is entitled to withdraw 25% of the value of the pension as a tax-free lump sum on the date that the member starts to enjoy benefits.