Techzone

The unique combination of tax breaks and flexible access available to pensions make them a compelling choice for savers.

So how do your clients make the most of this opportunity in a tax efficient way?

The maximum amount an individual and/or their employer pay into a pension will normally be influenced by the answers to the following questions:

1. Will they get tax relief on the whole amount paid in?
2. Will it be covered by their annual allowance (including anything carried forward)?

Generally, the maximum paid into a client's pension will be the lower of the amount that's tax relievable and the total of unused allowances.

Previously, clients would also need to be mindful of exceeding the lifetime allowance (LTA). But LTA tax charges ceased to apply from 6 April 2023 and the LTA was abolished completely from 6 April 2024. However, the overall amount of tax-free cash available is still limited, now by the ‘lump sum allowance’ (LSA). The standard LSA is set at £268,275 for those who don’t have transitional protection.

Any benefits which are taken after the client has used up their LSA will be fully taxable as income. This means pension saving will be tax neutral if the rate of tax relief received mirrors the rate of tax when benefits are taken. But of course, those pension savings will still enjoy investment returns within the pension which are free of income tax and CGT and the pension will generally be outside the estate for IHT purposes.

Tax relief

Individuals

Tax relief will be limited to the higher of 100% of relevant UK earnings, or £3,600. Tax relief is not available to anyone aged 75 and over.

Relevant UK earnings are broadly:

• Employees - gross earnings from 6 April to 5 April
• Self-employed - their share of profits from the trading year ending in the tax year

Relevant earnings do not include:

• dividends
• interest
• pensions in payment

Of course, some individuals may find it difficult to accurately predict their earnings - particularly if making contributions early in a tax year. So it may be necessary to initially err on the side of caution, then top up once an accurate figure is known.

Rule of thumb:

To get higher rate relief on the whole contribution, ensure the client's income less the gross amount of individual pension contributions made remains above their higher rate threshold. And make sure that they have sufficient unused allowance to carry forward (in both years if splitting the payment over two years).

Other possible benefits of making pension contributions

Other tax related considerations that may apply to some clients relates to the personal allowance and child benefit. The personal allowance is withdrawn by £1 for every £2 that 'adjusted net income' exceeds £100,000 and child benefit is effectively reduced by £1 for every £200 of adjusted net income over £60,000. A gross individual pension contribution reduces adjusted net income and may therefore restore some or all of these benefits.

Employers

To be allowed as a deduction from profits before tax, payments made into the pension scheme of an employee must be 'wholly and exclusively' for the purpose of the business.

For most employees this won't be an issue as the promise of a pension contribution will be in their contract of employment and so effectively part of their pay.

Business owners themselves may wish to take their 'remuneration' in different ways - whether by salary, dividend, pension contribution or a mix of any or all of these. HMRC accept this situation and will generally allow pension contributions as a deduction, provided they don't think the overall benefits package is excessive.

However, HMRC are less likely to allow relief if the total of all benefits taken results in a trading loss. So it may not matter that a business has sufficient 'cash in bank' to pay a large contribution if it doesn't have the profits to justify the payment. Relief may not be allowed in full unless it can be justified on another basis - for example, there has been inadequate pension provision in the past as profits were re-invested in capital projects for the business. And the profits referred to here are profits in the accounting period of the business, which may or may not coincide with the tax year (for example, if the accounting period runs from 1 June to 31 May each year, an employer pension contribution will be a deduction against profits in the 12 months to 31 May, not profits made in the tax year ending 5 April).

Annual allowance

Paying an amount that will receive tax relief is less effective if some of that tax relief is clawed back by the annual allowance tax charge. The current standard annual allowance is £60,000.

To avoid the charge, clients should also stay within their annual allowance, including any annual allowance carried forward. So how do they work this out?

Unused allowances must be used up in a specific order. The current year's annual allowance must be filled first, then the unused allowances from the three preceding years can be brought forward, starting with the earliest year. Taking each year in turn:

Current year - 2024/25

• It will reduce to £10,000 if the Money Purchase Annual Allowance (MPAA) has been triggered since 6 April 2015. This can happen for several reasons, including when clients have taken income under flexi-access drawdown (i.e. more than just their tax-free cash) or have taken benefits under the Uncrystallised Funds Pension Lump Sum rules (UFPLS). Before recommending further pension funding, you should check that your client has not done anything to trigger the MPAA.
  
  It's important to note that if they are subject to the MPAA, a client cannot use carry forward to pay more than £10,000 to a money purchase pension.
• It could be tapered down for high earners with income over £260,000 in the tax year (for these purposes, income is 'adjusted income' and includes the value of employer contributions). The allowance is reduced by £1 for every £2 of income over £260,000 until it reaches £10,000.
  
  But the full £60,000 allowance could be reinstated if the client can make a personal contribution large enough so that their 'threshold income' drops to £200,000 or less. Threshold income is their total income less any personal contributions (employer contributions are not added unless they’re in respect of a new salary sacrifice arrangement entered into after 8 July 2015).
  
  Some individuals may not be able to accurately predict their income for the tax year, so they may have to initially err on the side of caution, topping up once their allowance can be accurately established.

Having established the total allowance for the year, take off the contributions already made (including those due to be made) in the tax year by both employers and individuals. See the ‘DB Schemes’ section below if an individual is a member of a defined benefit scheme.

Carry forward years - 2021/22, 2022/23 and 2023/24

The standard annual allowance for tax years 2021/22 and 2022/23 was £40,000, although it could be affected by annual allowance tapering for high earners. The thresholds and minimum allowance for tapering were also lower in these years. Tapering applied where 'adjusted income' was over £240,000 and 'threshold income' also exceeded £200,000. Tapering stopped once the annual allowance reduced to £4,000.

The standard annual allowance and tapering limits for 2023/24 were the same as those that apply in 2024/25.

If the annual allowance has been exceeded in either 2022/23 or 2023/24 then, to make sure that the correct amount of unused allowance is calculated for 2024/25, it's necessary to look back three years prior to the year of that overpayment.

DB schemes

For defined benefit schemes, the amount that counts towards the pension input period isn't the amount actually paid in - it's based on the value of the increase in the benefits accrued over the tax year.

The input amount is calculated by subtracting the opening value of the benefits from the closing value. These values are calculated as:

• Opening value - the pension benefits at the start of the tax year are capitalised by multiplying the accrued pension by 16.
  
  If the scheme provides a separate lump sum in addition to the pension, the accrued lump sum is added to this value (this is typically seen in older public sector schemes).
  
  This total value is then allowed to be increased by the annual percentage CPI from September of the previous year. If the CPI figure is negative, the total remains the same, it does not decrease.
• Closing value - this is the increased pension amount at the end of the input period multiplied by 16.
  
  Add in the increased amount of any separate lump sum.

Subtract the opening value from the closing value and any positive result is the pension input amount for the tax year.