Are you maximising the tax relief on your pension contributions?
Retirement planning is evolving. As a hard-working partner, or other high-earning professional in a professional firm, it’s vital that you start planning for your retirement as early as possible. Beyond the standard retirement planning, understanding how you can maximise your allowance for pensions and make tax savings becomes paramount.
How can you reduce your tax bills?
A great way to reduce your income tax bill, if you can save your cash for the longer term, is to pay into your pension.
- You pay money in, you get tax relief at your highest rate.
- The pot grows completely free of income or capital gains tax.
- At retirement you can take a lump sum tax free, typically 25% of your pot, subject to certain limits.
- If you die, your pot can be passed to your nominated beneficiaries free of any inheritance tax. Depending on your age at the date of death, it’s also possible that any benefits your nominees draw could be tax free.
What are the drawbacks to some pensions?
Over the last 20 years we have seen a lot of change to pension legislation, and it is likely that there will be future changes to come.
Pensions remain one of the most tax efficient forms of savings you can have, but there are certain pitfalls, especially with older contracts. It’s essential you have your pensions reviewed to make sure they are effective as possible.
Abolition of the Lifetime Allowance
The government announced the abolition of the lifetime allowance back in March 2023 and this came into effect on 6 April 2024.
Although the Lifetime Allowance (LTA) has been abolished, the Lump Sum Allowance (LSA) and Lump Sum Death Benefits Allowance (LSDBA) have now been introduced along with the Transitional Tax-Free Amount Certificate.
However, the legislation is not yet finalised, and in the first draft there are technical errors that are being addressed.
In a HMRC newsletter issued on 4 April 2024, HMRC have even suggested that some people should consider deferring certain transfers, or drawing further benefits until the legislation had been fixed.
If you are thinking of taking benefits imminently it’s important that you seek independent advice before doing so.
Money In
There are limits on how much you can pay in each tax year. If you earn below £260,000 (including any company pension contributions, if relevant) you are likely to be able to pay up to £60,000 (including any company contributions).
If you earn over £360,000 you are likely to be capped at paying £10,000 per year into a pension.
If you earn anywhere in between…it’s complicated, take advice!
You might also be able to look back at the previous three tax years and sweep up any unused relief, known as “carry forwards relief”. Again, this can be complicated so take advice rather than make a mistake which can prove costly from a tax perspective.
Many savers with large pension pots may have stopped paying contributions over the last few years because they were close to, or over the lifetime allowance. Now that it has been abolished, there may be some circumstances when boosting your pension savings with lump sum contributions may be beneficial.
However, this might not be suitable in all circumstances, so it is worthwhile taking independent financial advice to see if it is in your interest or not.
Investment Options
Over the years, investment options have evolved, but some older pension contracts still have very limited and outdated investment options that represent poor value.
Modern contracts have a wide-ranging choice of investment solutions which, with appropriate advice, will meet the needs of most people, especially busy professionals.
Multiple pension pots
The days of a “job for life” seem a distant past, and it is easy for people to accrue a number of different pension pots. Think about looking to consolidate these. In some cases there could be a really good reason not to, for example if you were to lose a valuable guarantee, but in many cases consolidating your pensions helps you to simplify your overall retirement planning whilst making sure your pension pot is fit for purpose and suitable for you.
Retirement Options
Today’s retirement options are extremely flexible however, many older contracts are still limited to just buying an annuity.
It is possible to take some of your benefits tax free and this is typically 25% of the pot, subject to the LSA recently set at £268,250. It’s not necessary to take the lump sum all in one go, in fact sometimes it’s better to drip it out as part of the monthly income requirement, but not all contracts allow this.
It is possible to arrange the monthly income via an annuity purchase, or a drawdown from your pension. The correct decision for you depends on your circumstances and objectives so it’s essential to take advice not only during the accumulation stage, but more importantly when you start to access the benefits. Some decisions are irreversible, therefore it’s imperative they are correct.
Death Benefits
Older pension contracts don’t offer all of the flexibility that a modern contract does. This means that in some circumstances your beneficiaries’ only option might be to draw out everything as a lump sum, in certain circumstances this could be taxed as income on them as the recipient.
There is also the LSDBA referred to earlier. Modern schemes can avoid using any of this allowance meaning that on your death, more of your pension fund goes to your beneficiaries rather than HMRC.
A lot has changed in the pensions landscape over the last few years. You need to make sure your pensions are fit for purpose and will achieve the intended objective both in life, and on death.
Please get in touch if you would like to speak with one of our advisers to discuss retirement planning.