Tax relief for pension contributions
Paying into a pension can be tax-efficient. Although there are no limits on the amount that you can invest in a pension, there are limits on the amount of tax relief which is available. Further, to benefit from the tax relief, the contributions must be paid into a registered pension scheme.
There are various caps that limit the amount of tax relief that is available.
100% of earnings
The first limit on tax relievable pension contributions is your annual earnings. Subject to having sufficient annual allowance available, you can make tax relieved contributions to a pension scheme of 100% of your earnings. If you do not have any earnings or if your earnings are less than £3,600 a year, you can make gross contributions to a registered scheme of up to £3,600 a year (or someone can contribute on your behalf).
The annual allowance places a limit on the amount of tax-relieved pension contributions. The allowance is set for each year and any unused allowances can be carried forward for three years. The annual allowance for 2015/16 was set at £40,000, but as a result of measures announced in the Summer 2015 Budget to align the pension input period (which is the period against which the annual allowance is tested) with the tax year from 2016/17, it was possible to have an annual allowance of £80,000 for 2015/16 (plus any unused allowance carried forward from 2014/15, 2013/14 or 2012/13). However, the allowance is capped at £40,000 from Budget day (8 July 2015) to 5 April 2016.
The annual allowance was set at £40,000 for 2014/15 and at £50,000 for 2013/14 and 2012/13.
Employer contributions count towards the allowance.
Where pension savings are withdrawn after 6 April 2015 from a defined contribution scheme, the annual allowance may be reduced.
Relief given at marginal rate
Tax relief for pension contributions is given at your marginal rate of tax.
Where contributions are made to a personal pension, the contribution is paid net of basic rate tax. Thus a £8,000 actual contribution is the equivalent to a gross contribution of £10,000 paid net of basic rate tax of £2,000. Higher and additional rate relief is reclaimed through the self-assessment tax return.
Thus, a gross pension contribution of £10,000 costs a basic rate payer £8,000, a higher rate taxpayer £6,000 and an additional rate taxpayer £5,500.
A person with no or low earnings can make a contribution of up to £3,600 into a scheme. This will cost £2,880 net of basic rate tax.
Reduced annual allowance for high earners from 2016/17
From 2016/17 the annual allowance for those with earnings above £150,000 is reduced by £1 for every £2 by which income exceeds £150,000 until it reaches £10,000 (for persons earning £210,000 an above). Thus, for 2016/17, a person with earnings of £180,000 will be entitled to an annual allowance of £15,000 (£40,000 – (50% (£180,000 - £150,000)).
The lifetime allowance places a lifetime cap on tax relieved pension savings. The lifetime allowance is set at £1.25 million for 2015/16 and will reduce to £1 million on 6 April 2016. Tax charges apply if tax relieved pension savings exceed the lifetime allowance (although protections are available where this is only the case as a result of a reduction in the lifetime allowance).
It is likely that the pension tax relief landscape will change radically. The Government consulted on proposals for change following the summer 2015 Budget. So it may be a case of making the most of the existing rules while they remain available.
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