End of Year Pension Planning

We are fast approaching the end of the current tax year on 5 April 2022 so it is an ideal opportunity to review your taxable income and pension contributions. Higher and additional rate taxpayers receive tax relief at 40% and 45% on pension contributions, whereas basic rate taxpayers benefit from 20% tax relief. Contributions to registered pension schemes are exempt from income tax and pension funds grow tax free. You can’t carry back pension contributions so time is of the essence!

Contributions are particularly beneficial where taxable income is just above an income tax threshold. The higher rate tax threshold for 2021/22 is £50,270 and the additional rate tax threshold is £150,000. Individual’s with adjusted net income (total taxable income less gross Gift Aid donations and pension contributions paid net of basic rate tax under a relief at source scheme) between £100,000 and £125,140 have a marginal rate of tax of 60%. This is because £1 of tax free personal allowance is lost for every £2 of taxable income received over £100,000. If you fall into this bracket you could consider making a gross pension contribution to match the income received in excess of £100,000.

Tax relief on gross pension contributions made by an individual in a tax year are restricted to 100% of net relevant earnings and the pension annual allowance, whichever is lower, see below for further information:

NET RELEVANT EARNINGS

 The maximum gross contribution eligible for tax relief is the greater of £3,600 and 100% of an individual’s ‘relevant earnings’ – subject to the pension annual allowance. ‘Relevant earnings’ include employment income (including benefits), trading income, profits from furnished holiday lets and income from patents. Note that dividends are not ‘relevant earnings’.

PENSION ANNUAL ALLOWANCE

The annual allowance is a limit on the amount of accrued pension savings eligible for tax relief per tax year. This includes personal pension contributions, employer pension contributions and contributions from third parties. The annual allowance for 2021/22 is £40,000 but this is tapered for high income individuals and restricted to £4,000 for those who have flexibly accessed their pension. A high income individual is defined as having threshold income over £200,000 and adjusted income in excess of £240,000.

Threshold income is total taxable income plus pension contributions paid under salary sacrifice under an arrangement set up post 8 July 2015 less gross pension contributions paid to a relief at source pension scheme and any taxed lump sum death benefits

Adjusted income is total taxable income plus employer pension contributions and pension contributions paid under salary sacrifice less any taxed lump sum death benefits

If an individual exceeds both the threshold and adjusted income limits, their pension annual allowance is reduced by £1 for every £2 of adjusted income in excess of £240,000, to a minimum allowance of £4,000 where income is in excess of £312,000.

Unused relief from the previous three tax years can be carried forward. You must have been a member of a registered pension scheme in the tax year concerned. The current year’s annual allowance is used in priority. Unused allowances carried forward from 2018/19 will be lost if they are not utilised in the current tax year.

EMPLOYER PENSION CONTRIBUTIONS

Employer pension contributions are a tax efficient way of extracting capital from a business. The contributions are paid gross and an allowable expense for corporation tax if incurred wholly and exclusively for the purpose of the trade. If the remuneration package, inclusive of employer pension contributions, is excessive for the level of work done, this would not meet the wholly and exclusively test and the excess would not be deductible. Employer pension contributions are not restricted to an individual’s net relevant earnings but do count towards the pension annual allowance.

The temporary increase in National Insurance rates by 1.25% for 2022/23, followed by the introduction of the new Health and Social Care Levy in 2023/24 and the increase in dividend tax rates from April 2022 makes salary sacrifice arrangements particularly attractive. You could avoid the tax hikes by increasing your pension savings and if you are lucky, your employer might pass on some or all of the secondary Class 1 NICs saved!

CHILD BENEFIT, TAX FREE CHILDCARE AND 30 HOURS FREE CHILDCARE

Pension contributions can help families claw back their child benefit, which is progressively withdrawn where at least one parent or carer in a household has individual adjusted net income of more than £50,099. The High Income Child Benefit Charge claws back 1% of the amount received for every £100 of taxable income on a sliding scale between £50,099 and £60,000. With individual adjusted net income in excess of £60,000 the full amount of Child Benefit received must be repaid as a tax charge on the highest earner’s Tax Return.   

An added benefit of having individual total taxable income of £100,000 or less is that you are eligible for Tax Free Childcare and 30 hours free childcare. For further information, please follow this link https://www.fuseaccountants.co.uk/fusenews/tax-free-childcare

PENSION CONTRIBUTIONS TO REDUCE CAPITAL GAINS TAX

The basic rate tax band currently £37,700 will be extended by the gross amount of personal pension contributions made in a tax year. If taxable gains plus total taxable income received in 2021/22 fall within the extended basic rate tax band, capital gains tax would be payable at 10% (or 18% on residential property) instead of 20/28%.

PENSIONS AND INHERITANCE TAX

If an individual dies before taking any pension benefits before age 75, the fund remains outside the individual’s estate for inheritance tax purposes. On death after 75, the beneficiaries would inherit the funds free of inheritance tax, however, they would pay income tax at their marginal rate when they withdraw the funds either as an income or lump sum. This makes a pension a tax efficient way of passing on wealth on death.

LIFETIME ALLOWANCE

The lifetime allowance is the maximum permitted amount of tax-relieved savings across all pension funds. The lifetime allowance for 2021/22 is £1,073,100. If the value of your pension pot(s) exceeds the limit when benefits are drawn there is a tax charge of 55% of the excess if taken as a lump sum and 25% if taken as a pension income.

Planning Ahead

If you’d like to get ahead for the next tax year, why not join our next Tax Clinic on 6 April 2022 where we’ll be covering some of these points in more detail.

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FUSE is an independent Chartered Certified firm of accountants and tax advisors based in Highgate Village, North London. We provide a dynamic range of services to clients working in property, media, entertainment and professional services. Our clients vary in size from self employed sole traders, small enterprises and medium size businesses. We believe that comprehensive financial planning and sound business financial advice are the keys to growth and profitability.