Pensions have always been attractive for long term savings, but the Chancellor has made them even more appealing by removing the cap on the lifetime allowance, and increasing the annual contribution limits with effect from 6 April this year.
As a reminder, when you contribute to your pension, that contribution is boosted by a refund of the basic rate of income tax (20%) on the amount of your contribution. The pension provider claims that refund and adds it to your pension pot. In addition, if you are a higher or additional rate taxpayer you can reclaim the additional 20% or 25% of tax you paid. For a higher rate taxpayer, a contribution of £1,000 to a pension allows the pension administrator to reclaim £250, and the taxpayer enters the payment in their tax return and receives a refund of a further £250. So to boost a pension fund by £1,250 only costs a higher rate taxpayer £750. The figures are correspondingly even better for an additional rate taxpayer.
The tax benefits don’t end there: the pension is a tax efficient wrapper, with income arising in a pension fund, and gains realised, free of income and capital gains tax and no inheritance tax charges.
When you reach the age where you decide to draw down on your pension, you can on current rules take up to 25% of the pension as a tax free lump sum. After that, if you take more of the capital it will be subject to income tax in your hands at the rates in force at that time. Alternatively you could take the income from the pension, or use the fund to buy an annuity to provide for your retirement, both of which would be taxed at your then rates of tax.
The tax benefits don’t end there though: if a taxpayer dies before accessing their pension, in most cases the funds in that pension can pass free of inheritance tax to the beneficiary or beneficiaries nominated by the taxpayer. Even if the taxpayer has already taken benefits from their pension, some elements of the pension can pass to beneficiaries free of tax, and others can be used by those beneficiaries as part of their own retirement planning, providing them with an income (the rules are different if the taxpayer dies over the age of 75 or has taken an annuity). For that reason, we often suggest that a pension should be kept in place for as long as possible, with the taxpayer accessing other savings in priority to the pension.
Because of the very generous tax benefits the government has placed restrictions on pensions over the years. There is a contribution limit in place: taxpayers must in most cases earn income of at least the gross amount they are contributing to the pension (above a minimum of £2,880 a year), and there is a cap on contributions of £40,000 a year. It is this cap which has been increased to £60,000 a year. In addition, if a taxpayer earns in excess of £240,000 a year, their annual contribution cap is reduced in stages, to as little as £4,000 a year. That income threshold has now been increased to £260,000, and the annual contribution limit will now not be reduced below £10,000.
The other restriction was that the overall value of a taxpayer’s pensions was subject to a cap of £1.1 million. It is this cap that was blamed for many senior doctors retiring early, as pensions start to incur tax charges above that amount. The Chancellor was under pressure to increase that cap (it was previously as high as £1.8 million), but in a surprise move today he abolished the cap completely, meaning that pension funds of any value will now continue to enjoy privileged tax status. It might be time to look again at your pension, not just for your own retirement planning, but as part of your inheritance tax and pension planning for your children and other beneficiaries!
If you have any questions about the topics raised, please get in touch with our expert Estates, Tax & Succession team email@example.com.