2 useful examples of “carry forward” and pension tax relief in action
In an earlier article you read useful information about contributions to SIPPs, the tax benefits, and other areas to consider when a client is looking to make a payment.
While no two individuals’ circumstances are the same, most advisers we speak with would suggest that pension contributions should form part of an overall financial plan.
As well as the tax relief available, asset growth within the pension scheme is tax-free, there is the ability to take up 25% of the pension’s value as a pension commencement lump sum, and the distribution of death benefits has rarely been more flexible.
The argument that contributions paid into a pension are “locked in” have somewhat been placated in recent years by the flexibility offered in flexi-access drawdown.
We appreciate that this will not be news to advisers! That said, we thought that a couple of case studies of how tax relief is applied for both employee and employer contributions to SIPPs would be useful in illustrating these points, particularly as we approach a busy time of the year for payments into pensions.
Personal contributions
While individuals can reclaim tax relief at their marginal tax rate on personal pension contributions, the maximum gross contribution is limited to their earnings for that tax year, or the Annual Allowance, whichever is the lower.
Amounts paid over these limits are subject to tax charges, which in most instances must be settled through an individual’s self-assessment.
The Annual Allowance for 2020/21 is set at £40,000. However, there is the ability to carry forward unused tax relief for three previous tax years.
Note that it is important to remember the individual must have been a member of any registered pension scheme from the year they wish to carry forward from. Any contributions or benefit accrual from the tax year you are carrying forward from will need to be considered when working out the amount of Annual Allowance available.
Where clients exceed the Annual Allowance in the current tax year, it is the unused Annual Allowance from the earliest tax year which is used first.
An example
Jenny has earnings of £90,000 in the current tax year. She wishes to make a gross contribution of £70,000 to a new SIPP.
Although the Annual Allowance for the current tax year is £40,000, Jenny has a personal pension, which was set up by her previous employer from which she could carry any unused Annual Allowance.
Both Jenny and her previous employer had made contributions to this arrangement over the previous three tax years, limiting the amount she could carry forward:
- 2018/19 – Total contributions = £23,000
Available Annual Allowance = £17,000
- 2019/20 – Total contributions = £27,500
Available Annual Allowance = £12,500
- 2020/21 – Total contributions = £30,000
Available Annual Allowance = £10,000
Total Annual Allowance available to carry forward = £39,500.
With the current Annual Allowance and the carry forward from the 2018/19, 2019/20 and 2020/21 tax years, Jenny has sufficient Annual Allowance to pay the contribution.
To make a gross contribution of £70,000, Jenny only needs to pay £56,000 to her pension. The SIPP provider then reclaims the 20% basic relief of £14,000 on her behalf.
As Jenny is a higher-rate taxpayer, she is also entitled to higher-rate tax relief. This is eligible on her earnings over the higher-rate tax threshold of £50,270 for 2021/22.
This means she is able to reclaim an additional £7,946 in higher-rate tax relief, either through her self-assessment or by notifying her local tax office.
Taking into consideration the tax relief she is entitled to, the effective cost of a £70,000 contribution to Jenny is £48,054.
Employer contributions
The position of tax relief is different on employer contributions, as these are not paid out of earned income. As a result, there is not a link to earnings from a pension perspective, like there is for personal contributions.
However, consideration still needs to be given to the Annual Allowance to avoid an Annual Allowance charge.
Instead, tax relief is given to the company making the contribution by treating the payment as a business expense. This then allows the business to not pay Corporation Tax on the amount contributed.
While there is no link to an individual’s earnings, the contribution still needs to be deemed “wholly and exclusively” as a business expense to ensure it qualifies for Corporation Tax relief. This is something which the company accountant can help with.
Furthermore, unlike other payments made to employees, an employer pension contribution is not subject to National Insurance. This again presents another tax-saving opportunity.
An example
Elliott’s company wanted to make a £50,000 contribution to his existing SIPP. After speaking with the company’s accountant, it was determined that this amount would qualify for Corporation Tax relief.
Elliott already has a SIPP, which he had consolidated existing pensions into some years ago. As a result, he had sufficient Annual Allowance to carry forward and would not incur an Annual Allowance tax charge.
(Note that, if this contribution did exceed Elliott’s Annual Allowance for the current tax year, in most instances Elliott would have to settle the Annual Allowance tax charge personally. This would be based on the amount over the Annual Allowance and the rate at which he normally pays tax. For example, if he is a higher-rate taxpayer and the amount over the contribution was £10,000, Elliott would have to pay 40% of £10,000 (£4,000) as an Annual Allowance tax charge.)
As the full £50,000 was deemed to be a business expense, it qualifies for Corporation Tax relief. At a rate of 19% (2021/22) this reduces the company’s Corporation Tax bill by £9,500.
Furthermore, as National Insurance is not payable on employer pension contributions there is a further saving of 12% to the company on the payment (£6,000).
You may recall the proposed increase to National Insurance in 2022/23. You recently read about the impact of this and how pension contributions can help offset this increase. The article also lays out the tax benefits of paying employer contributions as opposed to net contributions from earnings.
Don’t forget the reductions to the Annual Allowance…
Unfortunately, there are still some frustrating tweaks to the Annual Allowance that you need to take into consideration based on an individual’s circumstances.
Tapered Annual Allowance
This is in place to control the amount of tax relief that is available to the highest earners. It will only apply where a client has a threshold income of over £200,000 and an adjusted income of over £240,000. Find further information on threshold and adjusted income here.
Where the taper applies, the Annual Allowance is reduced by £1 for every £2 that an individual’s adjusted income exceeds the £240,000 threshold. This reduction applies until the Annual Allowance reaches its minimum level of £4,000.
Money Purchase Annual Allowance (MPAA)
This applies where someone has flexibly accessed benefits from a pension scheme, resulting in an individual’s Annual Allowance being reduced to £4,000.
Further information on the MPAA and what can trigger it can be found here.
Get in touch
If you have any queries on using carry forward for your client, or if they face Annual Allowance issues, please get in touch. Email info@ipm-pensions.co.uk or call 01438 747 151.