There’s less than three weeks left to make the most of your tax breaks before the end of the tax year on 5 April. If you’re in a position to add to your savings, private pensions are the most tax-efficient mainstream investment option for the majority of people.
The caveat is that you’re tying money up until retirement – age 55 at the earliest – so whatever you save must be cash you can leave untouched. However, in return, pensions offer very generous tax breaks (see page 40). The key is to manage your annual allowance carefully.
How much you can pay in to your pension every year
The annual allowance is the maximum you can put into private pensions each year while still qualifying for the most generous tax treatment. If your annual income – including salary, income from savings and investments, and any other income you have coming in – is between £40,000 and £200,000, your allowance will normally be £40,000. If it is below £40,000, your annual allowance is the same as your income. If you have no income at all, it’s £3,600.
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If your income is above £200,000, a “tapered annual allowance” may apply. The rules here are more complex – you also need to factor in any pension contributions you receive from your employer, and whether your total income including this money is above £240,000. If so, your annual allowance reduces by £1 for each £2 you’re over the threshold, until you get to £312,000. If you’re above that figure, your annual allowance is fixed at £4,000.
Once you know the value of your annual allowance, you can work out how much you have left for the current tax year. That will depend on how much you have paid into your pension plans in 2021-2022 so far. This is a total figure that applies across all your pension plans, so if you belong to several, you will need to add them up. If you belong only to defined contribution schemes that do not offer a guaranteed pension in retirement, this calculation is straightforward. It is simply the total value of pension contributions made so far this tax year. Just remember that it is not only what you pay in yourself that counts, but also the tax relief you receive on those contributions, as well as any contributions made on your behalf by someone else, such as your employer.
If you belong to a defined benefit pension scheme, such as a final salary plan, the calculation is more complicated. The idea is to capture the amount by which your pension benefits in retirement have increased over the year. There is a complicated calculation for working that out, but your pension scheme administrator should be able to help. A financial adviser can also provide guidance.
Get it right or pay more tax
Getting the calculations right is important, because contributions above the annual allowance are subject to some quite expensive tax charges. You may still want to make these additional contributions, but it is important that you understand exactly where you stand.
If, on the other hand, you’re still some way off using your annual allowance in full, now is the time to consider topping up your contributions before the end of the tax year in order to grab those extra tax perks.
Make sure you carry over unused allowances
Savers butting up against their annual allowance may be able to make additional pension contributions using the carry forward rules. These allow you to use any unused annual allowance from the past three tax years to increase your contributions in the current one.
Let’s say, for example, that you have the full £40,000 annual allowance and that you made pensions contributions totalling £25,000, £30,000 and £35,000 in 2018-2019, 2019-2020, and 2020-2021. You would therefore have unused allowance of £30,000 from the past three years. Under the carry forward rules, you can add that to this year’s annual allowance, enabling you to contribute up to £70,000.
Pensions for non-earners
Even if you don’t have any earnings at all, you are still entitled to make pension contributions and claim tax relief. Non-earners are entitled to pay up to £3,600 into a private pension each tax year. Factoring in the value of the 20% tax relief you’re entitled to on such contributions, this will cost you just £2,880.
This can be a really useful perk for several different groups. For example, for women on maternity leave, the allowance provides a way to plug the pension savings gap at a time when they may not be earning an income. The same is true for parents taking time out of work to raise children – the working partner may be in a position to make pension contributions on their behalf. People who are not working because they are caring for somebody else may also be able to benefit from this.
Over time, the value of these pension contributions can grow into substantial amounts of savings as they are invested. And people’s circumstances change – non-earners may be in a position to contribute more if they begin earning an income, in which case, they will have a good base of pension savings to build on.
Non-earners include children. The rules allow parents to make pension contributions on children’s behalf, up to the £3,600 limit. They won’t be able to access this cash until much later in life – just like other pension savers – but it could be a useful foundation for their own retirement planning.
David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
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