The pensions allowance rules changed from 6 April 2020; Meg Saksida explains how.
Pensions savings can be extremely tax-efficient, as outlined below.
Pension tax breaks
Firstly, any pension contributions are made before income tax if they are in an occupational pension scheme; if in a personal pension scheme, any tax paid can be offset in the individual’s self-assessment tax return. Secondly, once in the scheme, any increases in the value of the funds are not taxed.
Finally, once they are being paid out to the pensioner (who will usually at this point have a reduced income and therefore a reduced tax rate band and a lower tax rate) depending on their other income, other tax benefits may be available such as the starting rate band, the personal savings allowance and the dividend allowance.
Annual allowance limit
However, despite the generosity of the pension saving system, there is a limit. Irrespective of the saver’s income, no more than £40,000 can be saved by the individual (including those amounts that his or her employers save on their behalf) if they wish to get tax relief on that contribution.
Once the saver’s total contribution to their pension is above £40,000 a year, there is an ‘annual allowance charge’ equivalent to the excess over £40,000 at the individual’s highest rate of tax.
However, this restriction goes even further. Introduced in 2016, there is also a restriction on the £40,000 annual allowance for those that have a high income. The level of income will depend on how much of the £40,000 the taxpayer is entitled to. Prior to April 2020, those earners with ‘threshold’ income over £110,000 and ‘adjusted income’ over £150,000 would suffer a loss of £1 of the annual allowance for every £2 over £150,000 an individual’s income was, down to a minimum of £10,000.
For example, if an individual had £170,000 adjusted income, this would represent £20,000 over £150,000 and therefore £10,000 annual allowance would be lost, leading to a £30,000 capacity for pension savings with tax relief, rather than the normal annual allowance of £40,000. These rules were especially harsh on public sector workers such as NHS doctors, GPs and Judges.
From April 2020, all the limits have been significantly increased, leaving only but the highest of earners at risk of having their annual allowances reduced.
The ‘threshold income’ has increased to £200,000 and the ‘adjusted income’ to £240,000. This means taxpayers will now suffer a loss of £1 of the annual allowance for every £2 over income of £240,000 an individual’s ‘threshold’ income was. However, the minimum has dropped to £4,000.
‘Threshold income’ is always considered first. This is the individual’s net income less any pension payments made with tax relief at source such as usually made to a personal pension plan. ‘Net income’ is defined as total income less any reliefs due. ‘Total income’ could be income from employment, self-employment, pensions, savings, dividends, properties or income from trusts. If the ‘threshold income’ is not above £200,000 ‘adjusted income’ does not need to be considered. If it is higher, ‘adjusted income’ should be measured, which also starts with net income, but adds any contributions made by employer and employees under a net pay arrangement.
In addition to the measures outlined above, the Chancellor increased the lifetime allowance. The lifetime allowance is a limit on the amount of pension benefit able to be drawn from a taxpayer’s pension pot without incurring an additional tax charge.
It is now at £1,073,100 from 6 April 2020; up from £1,030,000 in 2019/20.
An individual will now need to earn £300,000, rather than £210,000 previously, before they lose the whole of their annual allowance.