Grabbing pension tax relief by using carry forward allowances grows in importance

As the end of the tax year on 5 April fast approaches, savers and investors need to think about whether they are using their allowances to maximum effect.

One option for those with a lump sum to place or a sudden boost in earnings is to utilise their “carry forward” pension allowances.

Gary Smith, Director of Financial Planning at leading UK wealth manager Evelyn Partners, says the ability to carry forward your pension allowances provides a great opportunity to reduce your tax bill and save for retirement: “And this might be particularly opportune this year as Chancellor Jeremy Hunt has made it clear that he is prepared to make some hard decisions in order to stabilise the public finances.

“With the personal income allowance and thresholds frozen until 2028 – and in the case of the additional rate, being cut in April - many taxpayers will be quite sensibly looking towards pension saving in order to mitigate against income tax (and National Insurance) liability that is creeping ever-higher as nominal earnings increase across the economy.

“Entitlement to pension tax relief is being eroded as various allowances remain frozen, including the lifetime allowance, the annual allowance, the tapered annual allowance and the money purchase annual allowance, but the relief itself has so far escaped the grasp of the Treasury, and continues to operate at one’s marginal income tax rate. One wonders how long this will remain the case.

“All this means that those who are in a position to do, and particularly higher earners, should consider maximising pension contributions in advance of any potential future changes. And as it can be time-consuming to obtain all the information about previous years’ contributions (from your employer, your P60s, or your pension portal) and to arrange the contributions under carry forward: it’s best to start thinking about it now.”

While the annual pension allowance for most people is a gross amount of up to £40,000 – meaning the net cost for a 40% taxpayer is just £24,000 - those who have already maximised their current year’s allowance can also mop up any unutilised allowances for the three previous years.

“But there are some rules to note when thinking about carrying forward,” warns Smith:

• You must have first used up the current year’s allowance – so the first step is to get an accurate reading of this year’s contributions and take those to the limit.
• To get tax relief on pension contributions that you make yourself, you need to ensure that the payments made in any tax year do not exceed earnings in that year. An employer is not restricted by an individual’s earnings so they are able to pay in higher sums on occasion.
• You will need to have had a pension in each of the three previous tax years but you don’t need to have made any contributions and your new contributions do not have to be made into the same pension.
• Allowances from the ‘oldest year’ are used up first and at the end of every tax year, the oldest year falls away. Therefore, any allowances not used from the oldest year – now 2019/20 - will be lost for good if they are not carried forward, so it is worth checking one’s contribution history to see where there is most unused allowance.

“The ability to carry forward can be extremely useful for those looking to catch up on pension contributions because they want to give their pot a late boost before retirement, or because their financial position has improved and they want to take advantage of the tax reliefs on offer. For instance if they have received a lump sum or their earnings are higher than in previous years.

“Anyone over 50 years who receives a lump sum that they do not immediately need might consider ploughing it into their pension via carry forward as it will not be long before they can access a chunk of those savings tax-free anyway under pension freedom rules.

“It is also particularly useful for high earners those whose current year pension contributions are now restricted by the tapered allowance because they have a total income over £240,000. For anyone in this position, which can see their current year allowance drop to as low as £4,000 if they are in receipt of £312,000 or more then the opportunity to mop up unused allowances from previous year is one that should be seriously considered, especially if their earnings in those years were below the threshold for the tapered allowance.

“Carry forward has further benefits beyond retirement planning as maximising a pension can potentially remove funds from your estate for inheritance tax purposes and gives options to pass on wealth to your heirs in a very tax efficient way.

“However, there are also potential pitfalls. With the pension lifetime allowance now set at £1,073,100 for the next few years, care needs to be taken to ensure that contributions and growth in your investments won’t take you over this limit, as you will be liable for a tax charge on the excess when benefits are taken.

“Those earning between £125,140 and £150,000 will be paying the additional income tax rate of 45% from 6 April and this will translate into a greater tax relief boost on pension contributions, which might complicate decisions over carry forward.

“Questions around tax relief and carry forward can get very confusing and it’s always best to seek advice from a financial planner in these matters.”