We explore the tax perks of pensions and look at how they could impact pensions and retirement planning.
The tax perks of pensions are arguably unrivalled, as you can enjoy tax relief on contributions. You’ll typically get 20% paid by HM Revenue & Customs, and those who pay income tax at a higher or additional rate can claim additional relief on a self-assessment tax return to bring the total relief to either 40% or 45%.
What’s more, money invested in a pension grows free of Capital Gains Tax and Income Tax, which will enable your savings to grow much faster.
The Spring Budget offered a few surprises for pensions that took effect in April 2023.
Here we explore those changes in detail and how they could impact pensions and retirement planning.
There are limits placed on how much you can save each year without incurring a tax penalty.
In April 2023, the annual allowance was raised from £40,000 to £60,000 for most, although you can’t pay in more than you earn. The allowance includes your own and your employer's contributions and the amount paid in by HMRC.
If you exceed the annual allowance, pensions offer the unique benefit of being able to ‘carry forward’ unused annual allowances from the previous three tax years. The amount you carry forward is reduced by your annual allowance usage during those tax years.
There are different annual allowance rules for higher earners, however. The allowance reduces by £1 for every £2 earned over £260,000, which was increased from £240,000 in April 2023. This tapered allowance can drop to £10,000 – prior to April 2023 the allowance could drop to £4,000.
The annual allowance of £60,000 doesn’t apply to those who have started taking a flexible income from their pensions, however. There is a separate allowance (see MPAA section below).
Lifetime Allowance (LTA)
As of 6 April 2024, there will no longer be a maximum amount of pension savings that you can build up over your lifetime.
The limit, known as the Lifetime Allowance (LTA), is currently £1,073,100. Any excess was previously taxed at a maximum of 55% but as of April 2024 this will no longer be the case. Until then, while the LTA remains in place, the LTA tax charge will be removed, meaning no one will pay an LTA tax charge from 6 April 2023.
The changes mean that you can save into your pensions without the concern of a lifetime allowance tax charge should you breach the limit.
While there is no longer a limit on how much you can save in a pension for tax purposes, unless you have transitional protection, the tax-free lump sum you can take at retirement remains capped at £268,275 – 25% of the final LTA of £1,073,100.
In previous years, the LTA was higher. When the allowance was reduced, those with pensions that were likely to exceed the new lower allowance were able to apply for an official protection that would mean a higher allowance would be honoured; but in most cases, only as long as no more was paid into the pension after a certain date.
HMRC has confirmed1 that members that hold LTA protections will be able to accrue new pension benefits, join new arrangements or transfer without losing these protections – including the higher tax-free cash amounts – if they were applied for before 15 March 2023.
The carry forward options has become even more valuable now the lifetime allowance is being axed, because if you have funds to set aside, you can add to your pension.
The scrapping of the LTA tax charges means that more money can be passed on to next generations.
Your age at death determines how your pension death benefits are taxed, with different rules for those aged 75 and above.
Money Purchase Annual Allowance (MPAA)
If you start drawing directly from invested money purchase (defined contribution) pensions (over and above the tax-free lump sum), the amount that you can pay into a money purchase pension will be reduced to the lower, money purchase annual allowance.
This ensures money withdrawn from money purchase pensions isn’t used to fund further pension contributions on which you’d receive tax relief.
In April 2023 the money purchase annual allowance was increased to £10,000, from £4,000.
When you start to take a taxable income in this way, you'll also lose the ability to carry forward unused allowances into a money purchase pension. This means that it’s important to think about the amounts you want to pay into pensions before you start drawing taxable benefits.
Help is at hand
There’s no doubt about it – pensions can be complex, but are a vital tool for tax planning – and estate planning.
Speak to your Wealth Manager for your retirement planning and pension taxation needs.
Speak to your Wealth Manager or contact us if you would like to arrange a meeting with a Wealth Planner to discuss your options.
Your Wealth Planner can help you understand the effect of tax on your wealth and offer tax-efficient wrappers for your investments. They’ll be able to guide you towards making the right decision for your financial planning needs. Your planner can't offer tax advice – you should seek that independently.
This article does not constitute personal financial, tax or legal advice. Each person’s circumstances are different so if you are unsure about investing, you should speak to your Wealth Manager.
Things to consider
Please bear in mind that tax rules can change in future and their effects on you will depend on your individual circumstances.
The value of investments can fall as well as rise. You may get back less than you originally invested.
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