Money Matters - The Annual Allowance. "Tax relief"

After the success of the last five ‘money basics’ articles we are continuing this theme with a series of articles on focused subjects. The next five will be covering the overly complex subject of pensions in a little more detail.

Last week we discussed drawdown contracts under the new Flexi-Access Drawdown rules, this week we will cover off the Annual Allowance.

What is it?

There are two allowances as regards paying into pensions, the Annual Limit and the Annual Allowance.

The annual allowance is currently £40K a year, and you can use the previous three year’s annual allowance if you have not used them, so this year you can pay in up to £160K. Well, because they have changed the rules around input periods so they align with the tax year-end you can get away with a bit more than that, but for this year only.

The annual limit means the most you can pay into a pension is equivalent to 100% of your relevant UK earnings. There is a whole list of what constitutes relevant UK earnings, but dividends and pensions in payment do not count.

A company can make a payment on your behalf (tax deductible) up to any limit – but if it is over the annual allowance then a tax charge will apply.

As with most things to do with pensions, it is never that straightforward, there are some huge planning opportunities for pension contributions next year.

And one more thing…

If you’ve started to take money from your pensions since April 2015 then you’ve probably triggered something called the Money Purchase Annual Allowance, which means your allowance has fallen down to £10,000 a year. This was supposed to fall to £4K as part of the budget in spring 2017, but they forgot to put it in the finance bill this year.

So what’s this limit about?

Essentially, these limits apply to tax relief. If you pay in £100K, have £100K earnings, and have enough annual allowance then you get the equivalent of £40K tax relief - £20K upfront and £20K through an alteration to your coding from HMRC. You would also get your child benefit back if you have children and there are other benefits.

Most people do not have to worry about the annual allowance in any detail.

However, there are a few cases where average earners do have to worry about it.

Pensions tax planning for normal people

If you have worked for a firm for the past 40 years and are lucky enough to get a golden handshake just in time to retire then your settlement agreement might be over £30K.

You get £30K tax-free in the form of a settlement agreement, however you could get your employer to pay in the remainder directly to your pension and avoid paying tax on this – as long as you have your annual allowance remaining.

Alternatively, if you receive an inheritance and you want to maintain access to the money, but leave it in a location where you do not pay inheritance tax on it yourself – you should consider pensions.

And another thing…

Another limit on the AA is here, that people earning over £110K get assessed and the annual allowance is tapered from  £40K to £10K for those earning between £150K a year and £210K a year.

If you are in that bracket you should really contact your IFA, as the £110K is based on  personal contributions and net income – it might be better to pay larger pension contributions to get under the assessment threshold and pay the annual allowance charge than it would be to get assessed and lose your annual allowance.

What happens if I go over?

If you go over the limit then you have to pay back the tax relief that you were not entitled to – simple.

In some cases, it would make sense to do this.

Say you got a big inheritance of £500K and you wanted to make sure you never paid death tax on it:

Assuming £0 income has been earned (worst-case scenario) you would pay the £500K into a scheme using relief at source, you should then have a gross payment into the scheme of £625,000, and HMRC would take some of that tax relief back. As even low earners get a £3,600 allowance you would still have £500,720 in the pension, and would have saved yourself a potential £200K inheritance tax bill.

Phew...

That was a very brief run through of one of the simpler aspects of pensions and pension contributions.

Next week I will move on the mind-numbing lifetime allowance.

Contact us

Our in house Independent Financial Advisors can help you with all aspects of financial planning including pensions, investments and inheritance tax planning. If you need any legal advice, please contact the Chattertons’ Wealth Management team at your nearest office.