Darren Berry
Private Client Director
Saving into a pension is one of the most tax-efficient ways of building wealth. So, Jeremy Hunt’s 2023 Spring Budget announcement of a generous increase to the pension Annual Allowance, from £40,000 to £60,000, was great news for anyone looking to boost their retirement fund.
Additionally, the abolition of the Lifetime Allowance (LTA) – which previously limited the total amount you could save into a pension tax-efficiently – may allow you to build up a larger pension pot more quickly and bring forward the date at which work becomes optional.
However, despite the attractive tax advantages of saving into a pension, Professional Adviser has revealed that only a third of high net worth individuals have taken advantage of the increased Annual Allowance.
Read on to learn more about the increased pension Annual Allowance and discover the benefits of making the most of it.
The majority of high net worth individuals aren’t using their extra £20,000 pension allowance
Each tax year you can pay up to your Annual Allowance (or 100% of your earnings, if lower) into a pension without an additional tax charge.
However, according to research published by IFA Magazine, only a third of high net worth individuals are contributing more than the previous £40,000 limit, and just 8% are making full use of the new £60,000 allowance.
What’s more, the research shows that the average pension pot of high net worth individuals nearing retirement is £115,000 short of the amount necessary to provide their desired level of income.
And yet, the increased Annual Allowance provides a golden opportunity to accumulate more wealth tax-efficiently.
Using your full pension allowance could allow you to make more tax-efficient savings
Paying into a pension can be one of the most tax-efficient ways to save for retirement.
You’ll usually receive tax relief from the government on any contributions you make up to your Annual Allowance.
The tax relief for higher earners can be especially attractive. For example, if you’re an additional-rate taxpayer, you’ll receive 45% tax relief on any contributions you make up to your Annual Allowance. So, if you contribute the maximum £60,000, you could receive £27,000 in tax relief. This means that your contribution would only “cost” you £33,000.
However, your Annual Allowance might be reduced in some circumstances. For example, you might be subject to the Tapered Annual Allowance if your “threshold income” is more than £200,000, and your “adjusted income” is above £260,000.
In simple terms:
- Your threshold income is your annual income before tax, minus any personal pension contributions and ignoring any employer contributions.
- Your adjusted income includes all pension contributions, including any employer contributions.
If your income exceeds both the threshold and adjusted income limits, your Annual Allowance will be gradually reduced by £1 for every £2 or adjusted income above £260,000. If you earn more than £360,000, your Annual Allowance may have tapered to just £10,000.
One way of making the most of your Annual Allowance is to “carry forward” any unused allowance from the previous three tax years, even if you’re subject to the taper.
Imagine that your allowance has been tapered to £10,000 for 2024/25, but you have £30,000 of unused allowance from the previous three tax years. By carrying forward your unused allowances, you could boost your contributions by £40,000 this year.
Remember also that your gross earnings for the current tax year must cover your entire pension contribution, including the carry forward contribution.
It’s worth noting that if you’ve started to draw flexibly from your pension, you might have triggered the Money Purchase Annual Allowance (MPAA), which could reduce your Annual Allowance to £10,000. Unfortunately, once you’re subject to the MPAA, you can no longer use the carry forward option.
So, you might benefit from speaking to a financial planner before drawing from your pension, to ensure you’re making the most of any opportunities to enhance your wealth.
If you’re the owner-manager of a limited company, a pension is one of the most tax-efficient ways to extract profits
If you’re a director of your own limited company, a pension is one of the most tax-efficient ways to extract profits from a company.
This is because you can contribute to your pension both as an employer and an individual – and receive tax relief on both up to the full Annual Allowance.
What’s more, company pension contributions are usually classed as an allowable business expense and can be offset against your profit, reducing a potential Corporation Tax bill.
A financial planner can help you make the most of your pension allowance
Navigating the complex rules of pension allowances can be tricky. There may also be tax efficiencies you could be making that you’re unaware of.
Indeed, the low uptake of the increased Annual Allowance by high net worth individuals may be due at least in part to many people either not being aware of, or not understanding the change.
A financial planner can help you save more tax-efficiently by making full use of your allowances. This could allow you to build the income you need to live your desired retirement lifestyle, or even give you the freedom to leave work earlier.
To find out how we can help you make the most of your pension allowance, please get in touch.
Contact us online or call 020 7400 4700.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Workplace pensions are regulated by The Pension Regulator.
