Why you should pay more into your pension while you can
There is never a dull moment where pensions are concerned but the Emergency Budget on 8 July and the subsequent Green Paper on the future of pensions tax relief herald the potential for unprecedented change.
We are all aware that the Government needs to raise more money to shrink the country’s deficit and tax relief is an obvious area to explore. In particular the tax relief given on pension contributions you or your employer pay, as well as the national insurance contributions that are lost when people use salary sacrifice in lieu of pension contributions. So how will the new changes impact you and what action should you take?
Annual allowance tapering
The first change we will see is the introduction of tapering on the annual allowance – the maximum amount you can pay into a pension each year. This was one of the original proposals in the Conservative manifesto. So, if you earn over £150,000 a year, which would also include your employer pension contributions, your annual allowance will reduce by £1 for every £2 of income which is over the £150,000 threshold. This sounds quite complicated but in practice means that if you are earning £210,000 a year you are £60,000 over the £150,000 and your annual allowance will be reduced to just £10,000 a year. Thankfully, the taper stops at this £10,000 point meaning irrespective of earnings everyone will continue to enjoy a minimum annual allowance at this level.
This tapering of the annual allowance at £150,000 sounds like a high salary but when you consider that it includes pension contributions this could affect you if your basic earnings are £110,000.
There is one area that we await clarification on and that is the possibility of a change in how pensions are taxed. At the moment this is known as an ‘exempt exempt taxed’ (EET) regime, which means that money going into the pension receives tax relief, it grows tax free and is taxed when you receive it in retirement. But the suggestion is that this could be changed to ‘taxed exempt exempt’ (TEE) – similar to the treatment for ISAs. This means that the money going into your pension is from your taxed income. It has also been proposed that there is a limit on the contributions you can make into your pension to what has been termed a P-ISA and this could be as low as £16,000 p.a.
The final suggested change in this overhaul of the pension system is a single level of tax relief for everyone. Current indications suggest 30%, effectively reducing tax relief for everyone except basic rate tax earners
At the moment only the tapering on the annual allowance has been implemented and it isn’t clear if any of the other proposals will be introduced or when this might happen but for anyone that has the ability to pay more into their pension before 5 April 2016, it would certainly be worth thinking about. This is especially true for higher rate tax payers.
Paying more into your pension
The one piece of good news in all this change is that the pension input periods (PIPs) for all pensions will now be aligned with the tax year. A PIP is a period used to measure contributions against annual limits. This will make it much easier for everyone to understand how much they can pay into their pension and when. This is also an opportunity to pay more into your pension as there is a new mini input period for everyone which started on 9 July and runs until the end of the tax year. So if you haven’t paid into your pension in this tax year, you will have an annual allowance of £40,000 (subject to earnings) and even if you have contributed prior to 9 July, a further annual allowance of up to £40,000 may be available.
It is also worth investigating if you are able to carry forward any unused annual allowances from the last three tax years. Each individual’s circumstances will be different but it may be possible to carry forward from the 2012/13 tax year during which the annual allowance was £50,000. This does get quite complex and it is important that you contact your financial adviser if you don’t want to risk a tax charge for paying more than your annual allowance.
When pension freedoms came into effect from April this year, we were all encouraged to take control of our retirement savings and given the flexibility to pass them down to future generations. You can now be more flexible in how you take the money – no longer do you have to buy an annuity. I think it is safe to say that we have never had it so good with pensions and it looks as if it is unlikely that we will again, so consider maximising your benefits now.
Martin Tilley is director of technical services at Dentons Pension Management