Understanding Tax Relief on Pension Contributions

Did you know that there is such a thing as over-contributing to your pension? That’s right, if you contribute too much to your pension fund, you may end with taxation consequences. Unfortunately, these restrictions can be very confusing depending on your individual circumstances. With this in mind, here’s an article on everything to do with tax relief on pension contributions:

Annual and Lifetime Pension Contribution Allowances

When it comes to pension contributions, there is an annual allowance that applies to individuals. This annual limit applies to all your contributions. This includes everything from your personal, employer, and any contributions from third parties. This also limits the benefits you build up through schemes like the final salary scheme, for example.

As an employee, you can receive tax-free contributions up to the maximum standard allowance minus any restrictions and payments you make to other pension schemes. For the 2018/2019 tax year, the annual allowance is £40,000. This allowance can vary year on year so make sure to check with your local accountant for any updates that may affect you.

When it comes to tax relief on pension contributions, it depends largely on your annual allowance. This varies according to your earnings and the type of pension scheme you invest in. For some, the allowance can be as little as £4,000 a year.

Additionally, if your adjusted income is more than £150,000 and your threshold income is more than £110,000, you will see a reduction in your annual allowance. In these circumstances, your annual allowance can go down to as little as £10,000. If you exceed your annual allowance, you will have to pay an extra pension contributions tax.

Despite the above, you can use a carry forward allowance to expand your annual allowance. This will allow you to accumulate unused annual allowances from the past three years to your current annual allowance. You must be part of a registered pension scheme during that period to carry forward your annual allowance.

Additionally, there is a lifetime limit that applies to pension fund values from the combination of your registered funds. This limit is currently £1.3 million for 2018 and 2019. This will increase with inflation at the end of the 2019 tax year.

Money Purchase Allowance and Opting for Protection

If you’re part of a scheme and you access your benefits, your annual contribution allowance will automatically fall to £4,000. If you have defined benefits and contributions, your alternative annual pension will be £36,000 in 2018/2019.

Luckily, there is a way to better protect your lifetime allowance. However, by opting for this protection, you no longer have the option of making any extra pension contributions to new or current arrangements. You can only do this if you no longer wish to retain your protections.

Employer and Employee Contributions

No matter what your salary is, employer contributions aren’t limited to a registered pension scheme. That said, these pension contributions must satisfy the ‘wholly and exclusively’ requirements to qualify for tax relief. If these contributions exceed these requirements, the employee may have to pay charges on the excess.

As an employee making your own contributions, you must meet the relevant income requirements to qualify for tax relief on pension contributions. For example, if you make a contribution equal to your yearly salary at the end of the tax year, you won’t qualify.

Tax Relief on Pension Contributions for Employers

As an employer, all contributions must be ‘wholly and exclusively’ for the purpose of the trade or company. These contributions are part of the employer’s profits and loss account. With this in mind, they reduce profit. HMRC sees these contributions as a deduction in the accounting period in which they’re paid.

Understanding Tax Charges

When it comes to tax relief on pension contributions, it’s important to know that you don’t have to pay tax on registered pension fund growth. In fact, you only have to pay tax when you take benefits that go over the tax-free allowance. In essence, there are two tax rates for annual and lifetime allowance charges. These are:

1. The annual allowance charge which is only applicable if the pension contributions exceed the annual allowance. This is taxed at the marginal rate depending on your salary bracket, i.e. 20%, 40% or 45%.
2. The lifetime allowance charge which is applicable where the value of registered pension scheme benefits go over the lifetime allowance. In this case, you will have to pay 55% of the excess in a lump sum and 25% if the amount isn’t paid as a lump sum.

Make Annual Checks With Your Local Accountant

The key to fully understanding tax relief on pension contributions is to make annual and lifetime allowance checks. Unfortunately, knowing where to start can be challenging. With this in mind, it’s important you work with a local accountant to avoid any extra fees in the future.

At Newnham & Son, we can help you avoid tax charges on excess contributions. We can also check your contribution position so that your pension is never overfunded. To find out more about our services and how we can help you make the best decisions with regards to your pension, contact us today.