Are you thinking more about your future? Perhaps you are at a stage in your career where your income has increased significantly, or you have received a decent bonus and your outgoings have reduced. A classic example of this is where your mortgage is paid off and your children have moved on and are no longer financially dependent on you. So now it’s time to (re-)focus on your own financial wellbeing.
Pension contributions and tax breaks
An obvious choice would be to top up your pension pot. This is an opportune time to accelerate your retirement planning by making a large contribution into a pension and benefitting from the generous tax breaks they offer. But perhaps you’re worried about the contributions limits on pensions.
While you can save up to 100% of your salary into a pension and receive full tax relief, you are still restricted by the pension annual allowance, which is £40,000 per tax year. Furthermore, for some individuals who are fortunate enough to have adjusted income in excess of £240,000, the annual allowance will be further reduced by tapering.
The pension annual allowance may also be reduced to £4,000 if you take a flexible income from your pension. This is known as the money purchase annual allowance.
So are there any other options available? Well, if you haven’t been contributing all that much over the last three years, then you may still have some unused annual allowance left which can be carried over to the current year, known as carry forward.
What is pension carry forward?
Pension carry forward enables you to use any unused annual allowance going back three tax years. Provided you were a member of a registered pension scheme in the three previous tax years then you can take advantage of this allowance (whether or not you paid any contributions into it). Therefore, once the annual allowance in the current tax year has been fully used (£40,000 or less if tapered), then you can make further contributions and still receive tax relief at your highest marginal rate. That said, you do not have to fully use it all in one go, you can stagger it over the next three years. When using up your carry forward entitlement, you use the oldest year first, so in the 2022/23 tax year that will be 2019/20 year’s allowance. The unused allowance of 2020/21 and 2021/22 tax years can be carried over to future years. This could be particularly useful to high earners whose allowance has been reduced because of pension tapering.
Pension tapering for high earners
Pension tapering is when your annual allowance is reduced from £40,000 because your adjusted income is above £240,000 (which includes employer pension contributions). Your allowance will reduce by £1 for every £2 of income above £240,000, to a minimum of £4,000.
How does pension carry forward work in practice?
To help illustrate this, we will look at the following scenario: Mr Jenkins has had a promotion and his salary has increased significantly to £270,000 per annum. He has made the following contributions over the past three years:
Tax Year Annual Allowance Pension Contributions Unused Allowance
2019/20 £40,000 £8,000 £32,000
2020/21 £40,000 £10,000 £30,000
2021/22 £40,000 £12,000 £28,000
2022/23 £25,000* £10,000 £15,000
*Tapered annual allowance
As you see, Mr Jenkins’ current annual allowance has been reduced this tax year because of tapering. Consequently, he only has £15,000 of the current year’s annual allowance available. However, if we include carry forward from the previous three years’ unused allowances, Mr Jenkins could make an additional £90,000 contribution. Furthermore, as personal contributions reduce your threshold income, if Mr Jenkins contributed over £70,000 then his threshold income will be deemed to be below £200,000 and as such reinstate his full annual allowance of £40,000 in the current tax year. This would enable Mr Jenkins to contribute even further and make a one-off lump sum contribution of £120,000 over and above the current contributions he has already made.
Pension tax relief
Pension contributions enjoy generous tax relief so for each £1 an individual makes, the pension provider claims 20% basic rate tax which is added directly to your pension. Higher rate and additional rate tax relief can be claimed through self-assessment. Therefore, in the above example, Mr Jenkins will receive tax relief at his highest marginal rate, so for an additional contribution of £120,000 he would make a net contribution of £96,000 and reclaim additional rate relief through his tax returns. In this example, the whole contribution of £120,000 would receive tax relief at 45%/46%.
What if you run your own business?
If you run your own business as a limited company, then you can still take advantage of pension carry forward, however, you are not restricted to 100% of relevant earnings as you would be for a personal contribution. An employer can make pension contributions and offset them as an expense to the business which reduces corporation tax, provided the employer can demonstrate to HMRC that the contribution has been paid for the benefit of the business.
Speak to Tilney about carry forward
Tilney has a nationwide team of financial planners who are experienced at helping people with their pensions and wider financial planning. If you would like to find out more about using carry forward or have questions that you would like answering, we would like to offer you the opportunity to have an initial consultation with one of our financial planners. There is no charge for this meeting and you are under no obligations to take up any of our services.
Examples of how tax or tax relief may apply are based on our understanding of current tax legislation. Whether any tax will be payable, at what level it is charged and whether you qualify for tax relief will depend upon individual circumstances and may be subject to change in the future.
Issued by Tilney Financial Planning Limited.
This article was previously published on Tilney prior to the launch of Evelyn Partners.