I have found it is becoming more and more common for clients to seek options for maximising their pension for retirement through additional contributions.
As we know, the most you can personally pay into your pension (and get full tax relief) in a tax year is up to 100% of your relevant UK earnings, capped at £40,000 gross – however, it isn’t often you come across a client who can afford to continually maximise these contributions, be it either through their salary sacrifice arrangement and/or personal contributions.
More commonly, I see clients who would like to discuss their options as they have been in receipt of a recent windfall, whether it’s through an inheritance gift, house downsizing, or perhaps a larger-than-expected bonus payment. Plus, if clients do not have an immediate need for the extra money, or if they are thinking about the ‘bigger’ picture in retirement – this can lead to additional pension contribution discussions.
Carry forward calculations are extremely useful here, as they determine the scope for what a client can take forward as unused allowances from the previous three tax years. This can be an especially powerful tool if the client is looking to make a one-off large contribution and has a lot of unused allowances.
However, you will need to remember that – as above – for tax relief purposes, individuals can only contribute up to 100% of their relevant earnings. Therefore, a client with earnings of £55,000, for example, cannot make a tax efficient £90,000 pension contribution in the same tax year.
Peaking at £255,000 for the tax year 2010/11 before dramatically reducing to £50,000 the following year (and then to £40,000 from 2014/15), the annual allowance has been affecting more and more clients. More recently, a tapering allowance has been implemented for pension savers, depending on their level of taxable income. Therefore, clients with a higher income earning potential of more than £110,000 may now be penalised with how much they can save into pensions as their £40,000 annual allowance starts to reduce (it will be reduced by £1 for every £2 of ‘adjusted’ income the client has over £150,000). The maximum reduction will be £30,000, leaving the tapered annual allowance as £10,000 for all those with adjusted income over £210,000.
However, remember the tapered annual allowance will only affect a client if their ‘threshold income’ is over £110,000 and ‘adjusted income’ is over £150,000.
Threshold income is classified as your total net income for the tax year (including all taxable income such as salary, bonuses, rental income and pension payments), but deducting the gross amount of pension savings (where tax relief was given at source), as well as deducting any lump sum death benefits received from a registered pension scheme.
Adjusted income, meanwhile, takes threshold income further by allowing for employer pension contributions to be included – this will prevent clients from avoiding the tapering by exchanging salary for employer pension contributions.
When it comes to higher earning clients, they may have – as they may not have been aware – unknowingly started using their carry forward allowances through regular pension payments. For example, say a client is on a base salary of £165,000 with a bonus of £20,000, and has 10% employee and 10% employer contributions, £33,000 of pension contributions. However, their adjusted income shows as £165,000 base salary plus £20,000 bonus plus £16,500 of employer contributions, giving an adjusted income of £201,500. As a result, their tapered annual allowance would now be £14,250 – far less than the client is currently contributing.
In the above example, the client is over their tapered annual allowance by £18,750. However, assuming this year’s income was from their recent promotion and they had unused allowances from their previous years, these contributions could be absorbed with the earliest year’s allowance used up first. Remember: they must have also been a member of an HMRC-registered pension scheme in the relevant tax year to claim unused allowance.
The client may have been unaware if they had unused allowances from previous years, however, since the taper was introduced in 2016/2017 (and we will soon be entering its fourth year of operation in 2019/20), I can imagine that high earning clients not actively engaging with a financial adviser may find themselves falling foul of their reduced annual allowance in the coming years.
If a client exceeds their annual allowance in a tax year – assuming they have no previous unused allowances – they will still receive tax relief on the excess contributions. However, this is effectively cancelled out as they will have to pay an annual allowance tax charge, which will be taxed at their highest marginal rate on the amount over their allowance.
I see this area of advice becoming more important in the coming tax years, with more and more individuals being affected by tapering combined with using up their remaining carry forward allowances and entering into advice regarding scheme pays or member pays. Some clients may not even be aware until it’s too late, so it is vital we highlight this to clients/enquiries to further strengthen trust and relationships.