You can go to a specific question and answer using the links below.
- How does tax relief work on pension contributions?
- How do I work out how much of my pension annual allowance I have used if I am a member of more than one pension plan?
- Do employer pension contributions count towards my pension annual allowance?
- How do I know if I’m paying enough into my pension?
- How can I access my pension income?
- Can I take my whole pension as a lump sum?
- If I take out a lump sum and I no longer need it, can I put it back into my pension?
- How do I pay tax on the income from my pensions?
- I’m still working and entitled to a company pension. Is it best to leave the pension to accumulate or to transfer it into another pension and claim higher-rate tax relief?
- Can I still work part-time as I get older and receive a pension income at the same time?
- What is trivial commutation?
- What are the rules surrounding small pension pots?
- When are pension benefits tested against the lifetime allowance?
- If I’m over the lifetime allowance, should I opt out of my workplace pension?
- Can pensions only be passed on to my family?
- Can my pension be passed on free of Inheritance Tax?
- Can I still pass my pension down free of Inheritance Tax if I have already started taking an income from it?
- Will a pension that I pass on form a part of my beneficiary’s pension lifetime allowance?
How does tax relief work on pension contributions?
The way in which Income Tax relief on pension contributions is calculated depends on the type of pension scheme under review and the level of Income Tax you pay.
The two main ways in which tax relief is given on pension contributions are through ‘net pay’ arrangements and the ‘relief at source’ method. Net pay arrangements operate exclusively through certain workplace pensions (usually occupational pension schemes). Contributions paid by you personally are deducted from your salary before Income Tax is calculated, which means that you benefit from full tax relief immediately. The second way is via relief at source, where the pension provider claims 20% (basic-rate tax) from HMRC on your behalf.
If you are a higher-rate taxpayer, higher-rate tax relief is either claimed through your employer’s payroll or via your tax return.
How do I work out how much of my pension annual allowance I have used if I am a member of more than one pension plan?
The pension annual allowance is based on the amount you have contributed to every pension scheme you are a member of during a tax year. The way you work out how much of it you have used depends on the type of pension plans you have:
- For money purchase pension schemes, it is the cumulative gross amount of both employer and employee contributions paid into all schemes during the tax year.
- For defined benefit schemes (also known as final salary schemes), it is calculated by a specific formula that works out the increase in value of the benefits (known as a ‘pension input amount’) over the tax year.
Do employer pension contributions count towards my pension annual allowance?
Yes, employer contributions count towards your pension annual allowance. If you are an active member of a defined benefit scheme, any contributions you have to pay personally as a condition of your membership will be included in the pension input amount accrued in the tax year. In other words, these contributions will not count separately towards the annual allowance as they do in the context of a defined contribution scheme.
How do I know if I’m paying enough into my pension?
This all depends on how much money you will need for your retirement. One of the best ways to calculate this is through the use of cashflow modelling. It shows you how much money you could have in the future and how much you need to save now in order to achieve the retirement that you want. You’ll easily be able to identify any potential shortfalls before it’s too late to make any changes.
How can I access my pension income?
You can access your pension from the age of 55. A defined contribution scheme can be drawn either in the form of a lump sum, an annuity or drawdown. A defined benefit scheme can only be drawn as an income, although part of the income may be paid at the outset in the form of a tax-free lump sum.
Can I take my whole pension as a lump sum?
You can take the money from a defined contribution scheme as one lump sum. Usually 25% of the pension fund value is tax-free, with the remaining amount being taxable at your highest marginal rate. Unless your pension provider holds a tax code for you, they will still deduct tax on a PAYE month one basis. This means that the pension provider will assume one twelfth of your personal allowance and one twelfth of each tax band. Any excess tax will need to be reclaimed via your tax return or by completing the appropriate tax reclaim forms.
If I take out a lump sum and I no longer need it, can I put it back into my pension?
This is possible provided the tax-free cash recycling rules have not been broken. If the amount of tax-free cash withdrawn, together with other tax free sums received over the last 12 months, is under £7,500, the recycling rules will not be triggered. Up to a maximum of £3,600 p.a. or 100% of your relevant earnings can be paid back in. Tax relief will only be available if you have sufficient pension annual allowance remaining. If tax-free cash recycling does apply – where tax-free cash is drawn out and then placed back into a pension to achieve further tax relief – the amount of tax-free cash drawn will be classed as an unauthorised payment and attract heavy tax charges.
How do I pay tax on the income from my pensions?
Apart from the initial tax-free cash, which usually equates to 25% of the pension value, the remaining amount of your pension is liable to Income Tax at your highest marginal rate. Your pension scheme provider will deduct any tax due using the PAYE system before paying out any income.
If you are not able to give your pension provider a statement of Income Tax for the tax year, such as a P45, you will be provided with an emergency tax code. Income Tax is deducted on a month one basis, which assumes that the same income will be drawn every month for the entire tax year. This means that only one twelfth of the personal allowance, basic-rate band and higher-rate band will be available for each payment. So, if a one-off payment is made via income drawdown, you will more than likely have to pay more tax than necessary and it will need to be reclaimed via your tax return or by completing the appropriate reclaim form.
I’m still working and entitled to a company pension. Is it best to leave the pension to accumulate or to transfer it into another pension and claim higher-rate tax relief?
It is generally best to accumulate a pension via a company scheme as you will benefit from employer contributions which may not be available if you opt out and make contributions into another personal pension. The minimum an employer needs to contribute in to an employee’s pension scheme is 3% of their salary between the lower and upper limit. Many employers offer more than this as an employment benefit.
Your employer may offer you the opportunity to make additional contributions via salary sacrifice. This has the added benefit of reducing your National Insurance cost and your employer may add the amount of employer National Insurance saved to the contribution.
Can I still work part-time as I get older and receive a pension income at the same time?
Yes – if you are 55 or older, there is nothing to stop you from continuing to work while drawing pension benefits. If you want to continue to make pension contributions, you may be restricted to the money purchase annual allowance of £4,000.
What is trivial commutation?
Trivial commutation is when a member of a defined benefit pension scheme exchanges all of their pension benefits and draws them out as a lump sum, provided the value of all their pensions (including pensions in payment) is less than £30,000. 25% of the lump sum will be tax-free and the balance will be taxed at your marginal rate. You must have reached the normal minimum retirement age (55) and have received the triviality lump sum within three months of the ‘nominated date’. Triviality payments can also be made on death.
What are the rules surrounding small pension pots?
If you have a pension which is worth less than £10,000, it can be drawn out as a lump sum. This will not use up any of your pension lifetime allowance nor will it trigger the money purchase annual allowance. Up to 25% of the lump sum is tax-free with the remaining amount taxable at your highest marginal rate. A maximum of three personal pensions and an unlimited amount of occupational pensions can be taken in this way.
When are pension benefits tested against the lifetime allowance?
Generally, pensions are tested against the lifetime allowance when benefits are drawn, the member dies or reaches the age of 75.
If I’m over the lifetime allowance, should I opt out of my workplace pension?
This depends on your individual circumstances and what alternatives your employer offers. For example, if your employer does not offer a higher salary in lieu of pension contributions, then remaining in the scheme may be more beneficial despite the lifetime allowance tax charge being applied.
Even if your employer does offer additional salary instead of pension contributions, if you are an additional-rate tax payer, you may still discover that you are no worse off by continuing to accrue your pension as normal. If you received extra salary in lieu of your employer’s contributions, your salary would attract an effective tax rate of 48.25% (i.e. 45% Income Tax plus the additional employee National Insurance of 3.25%).
Can pensions only be passed on to my family?
It depends on what type of pension you are passing on. If you have a defined contribution scheme, the benefits can be passed over on your death to whoever you choose. You need to complete an ‘expression of wishes’ document naming your beneficiaries, but the pension trustees will make the final decision over who receives the money. Depending on the rules of the pension scheme, the pension can be inherited by way of an annuity, drawdown or a lump sum.
Defined benefit schemes operate differently. The death benefits from these schemes can only be paid to a spouse or civil partner, or to a dependent child up to the age of 23 (unless they are dependent because of a disability).
Can my pension be passed on free of Inheritance Tax?
Generally, most pensions will fall outside of your estate for Inheritance Tax purposes. But there are certain circumstances in which a pension could become liable to Inheritance Tax:
- Old style schemes such as Retirement Annuity Contracts and Section 32s generally pay death benefits to your estate as a matter of course, as they are contract-based pensions.
- If there is a legal requirement for the pension trustees to pay the death benefits to a certain individual or trust.
- If contributions were made into a pension within two years before death and the person knew that they were in poor health, this can cause an Inheritance Tax liability.
- If a pension was transferred within two years of death and the person knew that they were in poor health, this could result in the transfer being challenged by HMRC on the grounds that it was potentially an Inheritance Tax mitigation exercise.
Can I still pass my pension down free of Inheritance Tax if I have already started taking an income from it?
Yes, but only if you are receiving an income via flexi-access drawdown. Even after the pension has been crystallised, it can be passed on free of Inheritance Tax, but capital protected annuities and any unpaid guaranteed income will form part of your estate.
Will a pension that I pass on form a part of my beneficiary’s pension lifetime allowance?
No, the pension will be tested against the lifetime allowance on your death, so an inherited pension will not use up the beneficiary’s lifetime allowance. Only pensions which a beneficiary has accumulated in their own right count towards their own pension lifetime allowance.
Any further questions?
If you have any further questions about your pension or would like to speak to someone about any of the matters raised here, contact Tilney now. You can either book an initial consultation online or call us on 020 7189 2400.
Issued by Tilney Financial Planning Limited.
Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change. This article is solely for information purposes and is not intended to be, and should not be construed as financial advice. If you are in doubt as to a course of action you should contact a professional adviser.
This article was previously published on Tilney prior to the launch of Evelyn Partners.