Pensions remain one of the most tax-efficient ways to save for retirement and should be a key part of financial planning. Understanding the latest rules and allowances can help you maximise your pension savings while avoiding potential tax pitfalls.
One of the key benefits of pensions is tax relief on contributions. If you are under age 75, you receive tax relief on contributions, subject to limits. Basic rate taxpayers receive 20% relief automatically, while higher rate taxpayers can reclaim an extra 20% and additional rate taxpayers 25%. For a basic rate taxpayer this means a contribution of £80 is effectively topped up to £100 by the government.
Investments within a pension grow tax-free, boosting long-term returns. Additionally, up to 25% of your pension can typically be withdrawn tax-free at normal pension age, providing flexibility in managing retirement income.
Changes to pension access
Since 2015, pension freedoms have allowed individuals to access their pensions from age 55, though this age is set to rise to 57 in 2028. Whilst full withdrawal is possible, it can result in significant tax charges, so careful planning is essential.
The annual pension contribution limit increased to £60,000 in April 2023. If unused, allowances from the previous three years can be carried forward under certain circumstances. However, for high earners, the allowance tapers once adjusted income exceeds £260,000, reducing by £1 for every £2 over this threshold to a minimum of £10,000.
The Money Purchase Annual Allowance, which applies once pensions have been flexibly accessed, also increased to £10,000.
As of April 2024, the LTA has been abolished. This has been replaced with new allowances:
The Lump Sum Allowance (LSA) caps tax-free lump sums at £268,275 if you hold a standard Lifetime Allowance.
The Lump Sum and Death Benefit Allowance (LSDBA) sets a total tax-free limit of £1,073,100, including serious ill-health lump sums and death benefits.
These changes create opportunities for individuals who previously limited pension contributions due to LTA concerns. Given the complexity, professional financial advice is recommended.
Upcoming pension death benefit changes
Currently, most pension death benefits remain outside an individual’s estate. However, from April 2027, they may form part of an estate for Inheritance Tax purposes. The government has consulted on this, and we await the outcome. Individuals should review their estate planning in due course.
Planning opportunities
Considering these changes, individuals should consider reviewing their pension strategy. The increased annual allowance means many can contribute more and tax traps such as the 60% tax rate for earnings over £100,000 can be mitigated through pension contributions.
For example, an individual earning £125,140 could contribute £25,140 to restore their full personal allowance, benefiting from significant tax relief. Similarly, those affected by the High-Income Child Benefit Charge (HICBC) may find pension contributions an effective way to reduce their taxable income.
Contributing to a pension through a limited company can bring significant tax advantages. Contributions can be treated as an allowable business expense and be offset against your corporation tax bill, provided they meet the ‘wholly and exclusively’ business purpose test.
Although the £60,000 annual allowance and tapering rules still apply, directors can also consider carry forward rules to use unused allowances from the past three years.
By carefully structuring pension contributions, individuals can maximise tax benefits and secure their financial future. Consulting an adviser is recommended before making substantial contributions.
For a more detailed exploration into this topic contact Gary by emailing gary.doolan@mha.co.uk or visit our website.
