Pension Allowance Issues – use it or lose it

As we quickly approach the next UK Budget and the ever demanding tax year end, Gregor Munro, Financial Planner at Johnston Carmichael Wealth, highlights some of the issues that he and the team frequently have to address.

Reduced annual allowance 

You will probably be aware that the annual amount you can contribute to pensions is limited to £40,000 pa. However in 2016/17, individuals with taxable income (employed earnings, dividends, rental income - essentially everything going into your tax return) over £110k need to consider their position.

If adjusted earnings exceed £150,000, then the amount you can contribute to pension in that tax year is reduced by £1 for every £2 of adjusted income over £150,000 (subject to a minimum annual allowance of £10k) see example below :-

Salary £100,000

Dividends £20,000

Employer Pension Contributions £40,000

Total = £160,000

£10,000 excess over £150,000 = £5,000 reduction in annual pension allowance (£10,000/2)

New annual allowance £35,000

If you breach the annual allowance, the excess is chargeable to income tax at your marginal rate as if you had earned it. Even those with defined benefit/final salary pensions not yet in payment, are also required to factor in the notional contribution you are deemed to have made during the year. 

Should you be concerned about this issue then there are steps you can take to mitigate the tax liability:

  • You can make use of unused annual allowance from previous years starting with 2013/14. In theory someone may be able to utilise £130k of unused allowance plus their allowance this year (assuming worst case for this year). However you must have the income in the current year to support your contribution.
  • In addition, the 2013/14 year will fall away when we reach 2017/18 as you can only look back across the past three years. 2013/14 provided an annual allowance of £50k which subsequently fell to £40k. 

Therefore our advice is to check your position in terms of income and previous contributions as we may be able to turn a problem into an opportunity.

We are finding many clients who have unused relief to help alleviate the problem for this year (and probably the following year), but thereafter a decision will need to be made as to whether they continue to contribute to their existing pension scheme.

Remember it is possible to ask a pension scheme to meet the above liability if you have contributed more than your annual allowance and the charge is more than £2k.

What else can I do?

Looking forwards we expect that despite their higher risk, VCT and EIS investments will increase in popularity as investors look for savings vehicles which offer tax reliefs, especially when they are restricted on pension contributions. VCT and EIS are very different investments and cannot be compared on a like for like basis, however they are worthy of further consideration for the appropriate individual.

Lifetime allowance 

This limit on pension savings is now £1m. However there is an opportunity for some people to secure £1.25m, or possibly more, but you have to act quickly to confirm the position before the tax year end. For some clients close to retirement, it may be worthy of further investigation. 

The direction of travel appears to be reduced tax relief and limits on pension contributions. Therefore careful planning is even more important and a diversified portfolio is essential to combat the ever changing legislation. 

Visit our Budget Hub

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