Deadline looming: What’s the best way to top up your pension before the end of the tax year
I want to top up my pension to get the most out of this year’s £40,000 annual allowance for tax relief.
I’ve paid very little into a pension through my working life but built up a big pot of cash savings.
There’s not much time left before April 6, so what should I do and are there any pitfalls I should avoid?
Ian Browne, a pensions expert at Old Mutual Wealth, replies: Tax year end is fast approaching, but there is still time to make the most of this year’s allowances.
However, time is of the essence as any time after April 5 and you’ll lose the tax benefits of this tax year.
Pensions are an extremely tax-efficient way to save as your private pension contributions are tax-free up to certain limits.
However, if you’re saving large amounts into your pension you need to be sure you abide by rules. These can be complicated if you are a high earner or want to pay in very large pension contributions.
You should consider speaking with a financial adviser if you are unsure.
How pension tax relief works
If you pay tax, the basic rule is that you’ll get tax relief on pension contributions of up to 100 per cent of your earnings or a £40,000 annual allowance, whichever is lower.
If you do not pay tax, the rule is you can pay up to £3,600 into your pension.
Basic-rate tax relief is given automatically. If, for example, you wish to make a gross pension contribution of £40,000, you only pay £32,000.
The pension scheme will claim basic rate tax relief of £8,000 (equivalent to 20 per cent basic rate tax 2017/18) on your behalf from HM Revenue & Customs and add it to your contribution to make a total gross contribution of £40,000.
Ian Browne: Your personal contributions to your pension – including using up allowance from previous years – cannot exceed 100% of your current year’s earnings
But rules differ depending on your income. In April 2016 the government introduced new ‘tapering’ rules that mean if your income is over £150,000 (including pension contributions), your allowance will be decreased for that tax year.
If you are affected by these ‘tapering rules’ your annual allowance is reduced by £1 for every £2 over £150,000. However, it will not drop below £10,000.
The government has some guidance online on how to work out your reduced annual allowance here.
If you are a higher-rate or additional rate taxpayer, you can claim any extra tax relief directly through your self-assessment tax return.
However, tax relief will not be given to you on money paid into your account by your employer or from another source.
If your contributions exceed the annual allowance you will be liable for income tax on the excess.
It is important to note your personal contributions to your pension scheme – including using up allowance carried forward from previous years – cannot exceed 100 per cent of your current year’s earnings.
How to get unused pension tax relief from previous years
Given you’ve paid very little into your pension it may be that you can utilise ‘carry forward’ rules. Carry forward allows you use your unused allowance from the previous three tax years to boost contributions to a registered pension scheme in the current tax year.
How much can you save into a pension after starting withdrawals?
Over-55s who dip into their defined contribution pensions are only able to put away £4,000 a year and still automatically qualify for tax relief. Read more here.
You can check if you have any unused allowances on the HMRC website here.
What if you have started making pension withdrawals?
There is one final rule that you need to be aware of. If you have a defined contribution pension, and you start to draw money from it, the annual allowance can reduce to £4,000.
This is called the ‘Money Purchase Annual Allowance’. If this applies to you, as well as being far more restricted with what you can pay in annually, you will not be able to take advantage of the carry forward rules.
The main situation when you will trigger the MPAA is when you withdraw a benefit from your pension and you are liable to income tax on some or all of that benefit. For example, if you put your pension into a flexi-access drawdown scheme and start to take income.
You will not normally trigger the MPAA if you take your tax-free cash and purchase a lifetime annuity.
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