Once the tax year ends on 5 April, you may rue missed opportunities to maximise tax-efficient savings. First, check you understand exactly how much you’re entitled to contribute to your pension this year. As a broad rule of thumb, the “annual allowance” caps your contributions (including any made by your employer) at the lower of £40,000 or the total value of your taxable earnings over the tax year. However, there are two important exceptions.
First, even non-earners are entitled to an annual allowance of £3,600, which costs them only £2,880 to make, since the government tops up such contributions with basic-rate income-tax relief.
Second, higher earners may be subject to a lower annual allowance. For those with incomes of between £150,000 and £210,000, the allowance declines by £1 for every £2 extra you earn, until it’s limited to £10,000 on earnings of £210,000 or more.
If you’re entitled to make additional payments into your pension before 5 April that you haven’t currently planned for, now is the time to think about doing so. Despite longstanding speculation that the government wants to cut pension tax reliefs, contributions still attract generous tax treatment.
You qualify for tax relief at your highest marginal rate of taxation, so it costs only £550, £600 and £800 for additional-rate, higher-rate and basic-rate taxpayers respectively to pay £1,000 into their pensions. In addition, pensions savings grow free from tax.
Bear in mind that pension plans can’t be accessed until you reach age 55 at the earliest, so it’s important only to contribute money you can afford to tie up for the long term. The other caveat here is that higher-rate and additional-rate taxpayers may need to claim some of their tax relief through their self-assessment tax returns, since most pension providers only claim basic-rate relief on savers’ contributions as a matter of course. Keep careful records of what you’ve paid in ready to complete your tax return.
Finally, even if you’re already on target to use your full annual allowance this tax year, you may still be able to pay in more. The carry-forward rules enable you to make use of any unused annual allowance from each of the past three years. That has the potential to add up to £120,000 to your annual allowance in 2018-2019.
Does it make sense to exceed the pension contributions cap?
Savers who exceed the annual allowance on pension contributions face punitive tax charges. They effectively pay tax on the excess at their highest marginal rate of income tax – potentially up to 45%.
However, this doesn’t mean overshooting the allowances is disastrous, particularly if the extra money is coming from contributions made by your employer. Indeed, passing up your employer’s contributions is effectively turning down extra pay.
The question for savers getting close to the annual allowance is whether the extra tax they’ll incur from going over the cap will eventually be outweighed by the additional pension benefits they secure from the extra saving. Where the money is coming from your employer, the answer is very likely to be yes – particularly in a defined-benefit occupational pension scheme, where pension entitlement builds up automatically, but also in defined-contribution schemes, assuming your savings deliver reasonable investment growth.
The complicating factor is that you have to pay the tax penalty upfront – potentially years before you receive the benefit of your extra saving. Occupational pension schemes offer a facility known as “scheme pays”, which gives you the right to ask the scheme to settle your tax bill if it’s more than £2,000. You will then repay this money in retirement, receiving pension benefits that have been adjusted to reflect your use of the facility.
For many, this will be tempting, since it doesn’t require you to find any money for a tax bill today. But in the long term, it’s likely to be more expensive, since interest charges are added to the money
you’ve been advanced, at a rate of inflation plus 2.8 percentage points. You may be better off, overall, paying the tax yourself.
Keep an eye on your fees
Good news for many pension savers: one of the UK’s largest workplace pension providers has announced a revamp of its charges, prompting speculation of a possible price war.
The People’s Pension, which manages workplace pensions for around four million people, is switching from a flat-rate charge of 0.5% for all members to a tiered structure.
From this summer, while savers with smaller funds will continue to pay 0.5% a year, the charge will fall on a sliding scale for larger pension funds. Savings above £50,000 will be charged at just 0.2%.
Hopefully, the People’s Pension’s move will persuade other major workplace pension
providers to review their charges. Pension-scheme members should also consider their options.
The move is a reminder that people with cash tied up in pension plans at employers they have now left should look into whether transferring their money to a new provider would secure them a better deal. This may also be a good opportunity to ascertain how much you have in old pensions.
Meanwhile, savers with an employer that continues to use a more expensive workplace pension provider should ask their human-resources departments why they are persisting with higher fees.