Pensions are one of the best tools you can use to grow your wealth over the long term, but in recent years individuals with earnings of over £150k have been significantly restricted from using them.
In this article we demonstrate how the new pension rules on tapering, announced in the March 2020 Budget, will impact you, and what changes you may need to make as part of your long term financial planning.
- Pensions Basics
- Changes to the rules and how it affects you
- Pension tax relief - quick and easy summary
- Why has this opportunity arisen?
- Compliance kept simple
- Get in touch
1. Pensions – The Basics
Pensions are a tax efficient way to save for your future:
- You receive income tax relief on the way in at your marginal rate (see section 3);
- Your investments can grow free of income and capital gains tax within your pensions;
- When you withdraw from your pensions, you can take 25% tax free (the remainder is subject to income tax at your marginal rate);
- Pensions are outside of your estate, that means 0% inheritance tax on death.
What are the limits?
- There is a limit on the total value of all your pensions, above which you will be will be taxed (this is called the lifetime allowance – currently £1,073,100, rising with inflation);
- The contributions you can make are limited each tax year by your annual allowance. This starts at £40,000 but reduces down for high earners. It’s this limit that has recently changed for some of us in 2020/21, as explored below.
2. Changes to the Rules, who it affects and why
Below is a simplified summary of how this may have affected you:
My income is less than £100,000: your annual allowance will not have changed .
My income is between £100,000 and £150,000: your annual allowance probably has remained at £40,000. But, if you earn between £100,000 and £125,000 you have a unique opportunity to get 60% income tax relief by investing in your pension.
My income is between £150,000 and £299,999: your annual allowance will have changed, increasing by up to £30,000 this tax year. This is an opportunity to save more via tax efficient pensions.
My income is over £300,000: your annual allowance will have been reduced. If you earn more than £312,000 then your annual allowance is now £4,000. If your current contributions are in excess of this, you will likely be better off redeploying some of your pension savings elsewhere. We are helping clients in this position to utilise other tax efficient vehicles that fit their long term financial plan, such as ISAs, General Investment Accounts, Venture Capital Trusts and Investment Bonds.
The calculations on tapering are complex so you should seek advice on this, but we’ve provided a simplified view above. The changes in rules will affect you depending on your income. For this we mean salary, bonus, rental income, pension income, dividends, interest and trust income.
A link to the details of the tapered annual allowance rules can be found here.
If you're not sure on how best to maximise the tax efficiency of your long term savings, simply get in touch to arrange a call with one of our partners.
3. Pension Tax Relief
You receive income tax relief on contributions you make to your pension, at your marginal rate. This translates into the following:
Basic Rate (20% relief): to get £100 in your pension it will cost you only £80.
Higher rate (40% relief): to get £100 in your pension it will cost you only £60.
Additional rate (45% relief): to get £100 in your pension it will cost you only £55.
Income between £100k-£125k (60% relief): to get £100 in your pension it will cost you only £40.
If your earnings stagger the tax bands, the tax relief will change proportionately. Basic rate relief of 20% is added at source with any additional rate relief coming in the form of a reduction in your income tax bill via self-assessment. For example, if you are a higher rate taxpayer and make a net £80 pension contribution (i.e. you put £80 in), then your pension will be topped up by a further £20 from HMRC and you can claim £20 off your income tax bill via self-assessment.
4. Why did this opportunity come about?
The government has made these changes because of the effect it was having on the delivery of public services. Taking the NHS as an example, and keeping it simple, the tapering rules of the annual allowance meant that important public servants were being dissuaded from taking on extra shifts because they might have been financially worse off due to the impact it would have on their pensions. This is their way of fixing it, and it happens to present opportunities for those with high incomes (between £150,000 and £300,000) who are not in the public service.
5. Compliance kept simple
This document is for UK retail investors. Circumstances vary for individuals and any personal opinions or firm opinions represented in this presentation should not be seen as advice or a recommendation to take any specific course of action. We are not tax advisers. Past performance is not a reliable indicator of future results. Investments may fall as well as rise, and you could get back less than your original investment. This is based on current legislation which is subject to change.
6. Let's talk…
How do you know if more pension contributions are right for you? Have a chat with one of our experts – we’re here to help you maximise your opportunities if it’s right for your financial goals. Simply click here to book a call with one of our partners to find out more.