Reducing your tax liability is one of the most effective ways to gain the most from your money. There may be plenty of opportunities available for mitigating your tax charges depending on factors such as your salary, age, savings and investments.
Where retirement ambitions are a factor too, it’s particularly worthwhile to explore personal pensions. Tax relief is one of the main advantages of building up a pension so it’s important to make the most of this opportunity.
How the annual allowance works
The annual allowance means that up to £40,000 investment can be made in any given year into an approved pension arrangement. The government will add basic-rate tax relief (20%) when you contribute into a pension which qualifies the investor for tax relief at their marginal rate.
If you’re a higher rate taxpayer (40%), you can claim up to a further 20% relief through your tax return; additional rate taxpayers (45%) can claim back up to a further 25% on top of the basic amount, meaning a £40,000 saving into their pension for a net cost of £22,000.
Carry forward of annual allowance
In 2021, there may also be the opportunity to maximise your contributions into a pension up to £160,000 without having to pay an annual allowance tax charge, providing you have not used any of your previous three years’ allowance.
Otherwise known as the carry forward option, this is available to those who haven’t used their full annual allowance from previous years. In order to qualify for relief, personal contributions must not be higher than your earnings in the tax year you make the contribution.
However, if the tapered annual allowance applied for the previous tax years, any individual annual allowance may have been less than £40,000 in those years.
Tapered annual allowance
The rules are different for those with a total taxable income of more than £240,000. Since 6 April 2020, individuals who fall under this bracket are subject to a restricted annual allowance for that tax year. For every £2 of income earned over £240,000, the annual allowance is reduced by £1. This reduced rate is rounded down to the nearest whole pound.
The maximum reduction is £36,000. This means that anyone with an income of £312,000 or more has an annual allowance of just £4,000. If you have a high income but are caught by the restriction, you may wish to reduce your contributions and/or those of your employer or an annual allowance charge will apply.
However, the tapered reduction doesn’t apply to anyone with ‘threshold income’ of under £200,000. This presents an attractive tax planning opportunity for those earning between £150,000 and £200,000. In addition, if these restrictions mean your annual allowance for the current year is reduced, you could still make use of the carry forward option.
Lifetime allowance
While the tax relief does count towards your total contribution, the lifetime allowance (LTA) limits the total value of your pension pot.
The LTA is the total amount you can hold in your combined pension pot without being subject to tax charges. For the 2020/21 tax year, it’s set at £1,073,100. We recommend speaking with an independent financial adviser if you have a high-value pension pot as you may be able to register for tax protection with HMRC.
Tax relief for under-75s
Finally, it’s worth knowing that if you’re a UK resident under the age of 75 then you qualify for tax relief even if you’re not earning. Those who pay 0% tax qualify for up to 20% relief. This is may be an advantage to, for example, parents who wish to make contributions to their children’s pension pots.
For advice and support with all aspects of tax relief and tax planning opportunities, please get in touch using our enquiry form.
Our year end tax planning webinar for 2020/21 explored a variety of areas, including pensions.
The information in this article does not constitute financial advice and is provided for general information purposes only. BKL Wealth Management shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.
All wealth management advice will be provided by our affiliated FCA registered company BKL Wealth Management Limited.
BKL Wealth Management Limited is an appointed representative of Vintage Wealth Management Limited which is authorised and regulated by the Financial Conduct Authority. FCA number 593380.