Year End Tax Planning: Pension Contributions
As we continue to consider year-end tax planning measures, in this article we take a look at the important area of pension contributions for business owners and entrepreneurs.
The concept behind investing in a pension scheme is sound. You get tax privileges as you put money in and whilst you invest. In addition, you only pay tax when you take money out and even then there is the tax-free lump sum to be taken.
By adequately funding a pension scheme, it becomes possible to consider inheritance tax planning as your post-retirement standard of living will have been secured.
Net relevant earnings
Tax relief on individual pension contributions (including any third-party contributions) is restricted to the higher of £3,600 or 100% of relevant UK earnings.
If the pension contributions in a tax year are more than 100% of their relevant earnings (or £3,600 if greater), no tax relief is given on the excess pension contributions. The excess contributions may be repaid, but pension providers are not obliged to refund such contributions. The excess tax relief claimed by the pension provider on the individual's behalf is returned to HMRC.
Employer contributions are not restricted by the employee’s relevant UK earnings. They do however, count towards the annual allowance and tapered annual allowance.
Annual allowance
The tax relief you will receive on your pension contributions is capped at the maximum of your earnings or, if less, the amount of £60,000 unless tapered. The tax relief will be given at your marginal tax rate.
It may be possible to carry forward unused relief for up to three years. In 2024/25, any unused relief available from the three previous years (up to £40,000 for each of 2021/22, 2022/23 and £60,000 for 2023/24) may be utilised with the current year allowance against your income in 2024/25.
Securing full tax relief will be subject to the level of your pensionable earnings.
Contributions made by your employer, including those made under a salary sacrifice arrangement, will also contribute to using up the annual allowance.
Moreover, no tax relief will be obtained for contributions in excess of this limit and you will be liable to an annual allowance charge to remove the tax relief on the excess contributions.
Restriction on pension tax relief for higher earners
The government introduced a taper to the annual allowance for those with taxable income in excess of £200,000 and adjusted income over £260,000 (taxable income plus individual and employer pension contributions). For every £2 of adjusted income over £260,000, an individual’s annual allowance will be reduced by £1, down to a minimum of £10,000.
If your employer pension contributions are reduced because of this restriction, you will need to agree payment of additional salary in compensation.
We hope you have found the suggestions above helpful. In our next article in this series, we will be looking at cars, fuel and salary sacrifice. You can find previous articles in this series: Year End Tax Planning.
As always, please contact us to discuss your circumstances with you.
These articles have been written to provide a general guide to potentially highly complex issues. Whilst great care has been taken in the production of these articles, they are intended to provide the clients and friends of Ritchie Phillips LLP with an outline of the issues individuals, families and trustees should consider and you should seek specific advice before taking or refraining from any action.
