8th February 2016 at 12:30pm
Pensions are still the most tax-efficient way to save for retirement. And the new freedoms have made it easier to access your savings and pass on pension funds as an inheritance.
With cuts to funding limits around the corner and new ones likely to be announced in the March 2016 Budget, making the most of opportunities to fund your pension becomes a ‘must-do’ as the tax-year end approaches on 6 April.
Here are 10 reasons to consider funding your pension before then.
Make the most of tax relief
You may want to make the most of what you contribute to your pension as the Government is currently reviewing pension tax relief. We expect to find out the Government’s plans in the Budget on 16 March.
Taking advantage of any carry-forward allowances to maximise what you can pay into your pension could make good financial sense too. (You can read more on carry forward below.)
The Annual Allowance: cut for higher earners
For some people, 2015-16 may be the last chance to benefit from the full £40,000 annual allowance – how much you can pay into your pension tax efficiently in one year.
From 6 April 2016, anyone earning over £150,000 in a tax year will see their standard £40,000 Annual Allowance reduced by £1 for every £2 of their income, until it reaches £10,000.
The Lifetime Allowance is going down to £1m
If you’re one of those affected by the lifetime allowance falling to £1m from April, you may want to consider weighing-up the pros and cons of two options open to you.
- ‘Fixed protection 2016’ would lock you into a £1.25m lifetime allowance but you’d have to stop paying into any pensions after 5 April 2016. So now might be a last opportunity to add further funds to your pension.
- ‘Individual protection 2016’ would give you a lifetime allowance of between £1m and £1.25m but you’d be able to keep saving. You’d need to choose this option if you have a pension fund of £1m or more at 5 April 2016, so you may need to save more before then to push it over the £1m limit by then.
You may have an additional Annual Allowance for 2015/16
You may not have heard much about them, but pension input periods (PIPs) are being brought into line with tax years from this April, and transitional rules for this year could see some people able to pay an extra £40,000 into their pension before 6 April 2016.
Until this change, PIPs didn’t need to align with the tax year.
The new rules effectively split 2015-16 into two mini-tax years either side of the 2015 summer Budget on 8 July.
As a result, there’s an increased annual allowance for the year: £80,000 is available for the pre-summer Budget part of the tax year and any unused part of the £80,000 (up to £40,000) can be paid before 6 April 2016.
Boost SIPP pension funds now before you take a flexible income
If you’re looking to take advantage of the new income flexibility from your pension for the first time, you may want to consider boosting your fund before April, potentially sweeping up this year’s full £40,000 annual allowance along with any unused carried forward allowances from the last three years.
Why? This is because once income has been accessed under the new rules, the annual allowance for money purchase/defined contribution schemes will drop to £10,000 and any unused carry forward allowances will be lost forever.
Anyone in capped drawdown (there is a limit on the amount of pension income you can take from your scheme each year which is regularly reviewed) before April 2015, or who only takes their tax-free cash, keeps the £40,000 allowance.
Don’t miss the chance to carry forward £50k
The most you could carry forward in unused allowances for the current year is £140,000 – £50,000 from each of the 2012-13 and 2013-14 years plus £40,000 from 2014-15.
This will drop to £130,000 in the next tax year from 6 April as its cut back by another £50,000, before settling at £120,000 in 2017-18. This is providing there are no further drops in the annual allowance.
Dividend changes and business owners
Many directors of small- and medium-sized companies may be facing a higher tax bill next year as a result of how dividends will be taxed. If this describes you, a pension contribution could cut your overall tax bill, while you still receive the same level of benefit.
It’s worth knowing that from 6 April, all dividend income greater than any unused personal allowance and the new £5,000 allowance will be taxable.
Pay more and get your personal allowance back
Contributing to your pension reduces your taxable income and can give you back your personal allowance.
If you’re a higher rate taxpayer with a taxable income of between £100,000 and £121,200, a pension contribution that reduces your taxable income to £100,000 would give an effective rate of tax relief of 60%. For those on higher incomes, or making bigger contributions, the effective rate would be between 40% and 60%.
The child benefit tax charge
If you have children, pension contributions can ensure the value of your child benefit is saved for your family, rather than being lost to the child benefit tax charge. It might be as simple as redirecting existing pension savings from the lower earning partner to the other.
Child benefit, worth over £2,500 a year to a family with three kids, is cancelled out by the child benefit tax charge if the taxable income of the highest earner reaches £60,000. There’s no tax charge if the highest earner has income of £50,000 or less, and the tax charge is tapered from £50,000-£60,000.
As a pension contribution reduces your taxable income, paying more could reduce the tax charge – even to zero. The combination of higher-rate tax relief on the contribution coupled with the child benefit tax charge saved can lead to an effective rate of tax relief of as much as 65% for a family with three children.
Sacrifice bonus for an employer pension contribution
March and April is the time of year when some companies pay annual bonuses to their employees. Sacrificing a bonus – or part of one – for an employer pension contribution before the tax-year end can be very tax efficient way of boosting your pension pot, and reduce your taxable income.
Of course, pensions and tax can be complex, so it’s well worth taking financial advice to find out what’s best for your circumstances.
A personal pension is an investment and its value can go up or down and may be worth less than you paid in. Laws and tax rules may change in the future.
The information in this blog or any response to comments should not be regarded as financial advice and is correct as of February 2016.