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The TYE presents an opportunity for clients to boost their pension savings by making the most of the allowances on offer.

The good news is that this year there have been no changes to the way in which tax relief is given, the amount of the annual allowance or the tapering criteria. So this year’s planning should be ‘business as usual’.

The key to maximising tax efficient pension funding at the year-end is understanding how much annual allowance is available (including any allowances carried forward) and the level of client earnings.

Annual allowance headroom

The annual allowance is £40,000 for the current year and each of the three previous ‘carry forward’ years. Potentially, this gives a maximum allowance of £160,000. To determine how much annual allowance is still available for each of these years, the £40,000 allowance must be reduced by any personal, employer or third party contributions made to any scheme in each year. All fairly straightforward.

For members of defined benefit schemes, things gets a little more complicated as the amount that counts towards the annual allowance is based on the annual benefit earned under the scheme over the tax year, rather than what has actually been paid by the client and their employer.

Our guide on ‘Annual allowance’ explains this in more detail.

The tapered allowance

Not everyone will have the full £40,000 available to them in the first place. High earners may have a reduced allowance due to ‘tapering’, and those who have already started flexibly drawing taxable income from their money purchase pension will be limited to the £4,000 money purchase annual allowance (MPAA).

For high earners, tapering kicks in if their adjusted income (AI) exceeds £240,000 and their threshold income (TI) exceeds £200,000. This is the case for both this year and last. Before that, the AI and TI limits were £150,000 and £110,00 respectively. This will be important when calculating the tapered annual allowance in each year and therefore how much can be carried forward to this year.

Adjusted income is broadly any income subject to tax (e.g. income from employment and savings income) plus the value of any employer contributions. Threshold income is also any income subject to tax, less any pension contributions paid by the individual - employer contributions do not get added unless they’re made by a new salary sacrifice arrangement entered into since 8 July 2015.

It’s therefore possible to counter tapering and retain the full annual allowance if a large enough personal contribution can be made to bring threshold income below £200,000 - the availability of carry forward can help facilitate this.

More detail on what is included in adjusted and threshold income can be found in our guide ‘Tapered annual allowance – adjusted income and threshold income’.

The earnings factor

The other limiting factor for tax relief is earnings. Individuals won't get tax relief if they pay more than their earnings in a tax year, even if they do have unused annual allowance. Business owners of a limited company who may not pay themselves much in salary can of course make a tax deductible ‘employer’ contribution, but this too could be limited by the annual profits of the business.

Employees may still be able to enter into a salary or bonus sacrifice arrangement with their employer. As well as National Insurance savings made by both parties, some employers may be willing to boost their contribution from these savings. However, as noted above, new salary sacrifice arrangements won't reduce threshold income and so won’t counter any tapering of the annual allowance for high earners.

The interaction of the annual allowance and earnings are discussed further in our guide ‘How to maximise pension savings’.

Why pension - why not ISA?

Ideally, clients will want to maximise their savings into both pensions and ISAs - both offer protection from income tax and CGT. If it comes down to a choice, however, while the simplicity of an ISA may be attractive, a pension remains the best way to save for retirement for most people. The combination of income tax relief on the way in and tax free cash on the way out means that, pound for pound, they will in most cases provide a higher net income than an ISA and most other investments.

Looking beyond retirement incomes, pensions also make family wealth transfer easier. Savings are generally protected from IHT, and the option of drawdown for beneficiaries not only extends IHT protection, but also means that investment income and gains remain tax free.

Summary

Pensions remain the best way for most clients to save for retirement. To make the most of the tax year end funding opportunity, advisers need to identify the available annual allowance and earnings. For some clients this will be a simple exercise. For others it might be a little more complex, but the benefits are clear.