Sarah Laing looks at how tax relief on pension contributions may be optimised and highlights why it might be beneficial to top up pension plans sooner rather than later.
There continues to be plenty of speculation concerning the availability of tax relief on pension contributions – not least because an unnamed senior government source recently quoted Chancellor Philip Hammond as saying that the £38 billion paid out every year in the form of pension tax relief is ‘one of the last remaining pots of gold we can raid’.
Although a rebellion prevented former Chancellor George Osborne from fully pushing ahead with his proposals back in 2016, he did manage to implement the first tranche of restrictions in this area. Speculation is now gathering pace that in a bid to find the extra money he urgently needs, Mr Hammond might well be about to announce further pension tax relief cuts.
Subject to certain conditions, tax relief is currently available on pension contributions at the highest rate of income tax paid, meaning that basic rate taxpayers get relief on contributions at 20%, higher rate taxpayers at 40%, and additional rate taxpayers at 45%. In Scotland, income tax is banded differently, and pension tax relief is applied in a slightly different way.
Relief on contributions
A contribution of £100 will currently only cost a basic rate taxpayer £80. The contribution is deemed as being made net of tax (£80) and the pension provider claims the tax relief (£20) from the government.
The gross contribution (£100) is invested in the pension plan. Higher rate and additional rate taxpayers need only pay £60 and £55 respectively to achieve the same £100 of pension savings.
Tapering of relief
Since 2016, tax relief on pension contributions has been restricted for people with income from any source amounting to more than £150,000. Broadly, the reduction means that the annual pension allowance has been reduced from £40,000 to £10,000 for those with income over £210,000. However, subject to certain conditions, it still remains possible to carry forward any unused annual allowance for up to three years prior to the tax year in question, meaning that there is still plenty of scope to make substantial contributions and obtain tax relief on them.
Even for those who are not affected by a reduced annual allowance, it seems sensible to ensure that pension contributions are paid at the earliest opportunity while there is certainty that tax relief at marginal rates can be obtained. Before the last Budget, there was talk of a possible flat rate relief on pension contributions. Although we cannot be certain what the future may hold, if a flat rate is introduced, it is unlikely that this will be at the equivalent level of higher and/or additional rate relief.
Tax relief for non-taxpayers
Pensions are a particularly tax-efficient form of savings since nearly everyone is entitled to receive relief on contributions up to an annual maximum, regardless of whether they pay tax or not. The maximum amount on which a non-taxpayer can currently receive basic rate tax relief is £3,600. So, an individual can pay in £2,880 a year, but £3,600 will be the amount actually invested by the pension provider. Higher amounts may be invested, but tax relief will not be given on the excess. Any tax relief received from HMRC on excess contributions may have to be repaid.
Of course, we cannot know in advance whether there will be any changes, but it is strongly recommended that anyone considering topping up their pension pot should think about doing it sooner rather than later.
Practical Tip:
Working out how best to utilise pension contributions tax relief can be complicated and seeking professional advice will always be recommended. It is worth noting that, subject to a couple of conditions, a new tax exemption may cover the first £500 worth of pension advice paid for by an employer. The exemption covers advice not only for pensions but also on the general financial and tax issues relating to pensions.
