WHO CAN HAVE A PERSONAL PENSION?
Pensions are retirement savings plans, so they’re usually arranged by adults at some point after they start earning an income. However, any UK resident can invest into a pension, from their day of birth or first day in the country and receive tax relief up to age 75 – imagine the compound growth after contributing for 60 years!
HOW MUCH CAN I INVEST?
Because of the significant tax advantages, contributions are restricted. The amount you can invest is limited by the Annual Allowance and the Lifetime Allowance.
The gross amount you can invest (and achieve income tax relief on) is £3,600, or 100% of your earned income, whichever is greater, up to a limit of £40,000.
The £40,000 is called the Annual Allowance and is the annual limit for pension payments.
I earn £20,000, how much can I pay into a pension?
This would be £20,000.
I would like to pay into a pension for my son who is 3 years old, how much can I invest?
Because your son has no income, you can save up to £3,600 per year.
You are restricted on the total of all pension benefits (excluding the state pension) you build up during your lifetime.
You are limited to £1 million of pension benefits, which is the fund value of your personal pension, plus 20 times the expected income from any defined benefit pension, plus any tax-free cash which may be paid in addition.
The lifetime allowance has been reduced over the years and if your funds are in excess of £1.25 million, you may be able to apply for some protection on your fund. You should seek advice in relation to this from Lexington Wealth.
Higher earners annual allowance limit or tapered annual allowance
Since 6 April 2016, individuals who have taxable income for a tax year of greater than £150,000 (this includes all income, from all sources) will have their annual allowance (the £40,000) for that tax year restricted. It will be reduced, so that for every £2 of income they have over £150,000, their annual allowance is reduced by £1. Any resulting reduced annual allowance is rounded down to the nearest whole pound.
The maximum reduction will be £30,000, so anyone with income of £210,000 or more will have an annual allowance of £10,000 (£40,000 – £30,000). High income individuals caught by the restriction may therefore have to reduce the contributions paid by them and/or their employers or suffer an annual allowance charge.
This affects members of Occupational Defined Benefit pensions too.
However the tapered reduction doesn’t apply to anyone with ‘threshold income’ of no more than £110,000.
Clearly the definitions of the two incomes are crucial to understanding whether someone is affected by the tapered reduction or not.
Find out how to calculate your tapered allowance.
Where an individual flexibly accesses their pension savings they are subject to the money purchase annual allowance.
Individuals who have flexibly accessed their pension savings will have a money purchase annual allowance of £4,000 (2017/18).
CARRY FORWARD UNUSED ANNUAL ALLOWANCE
If you don’t use all of your Annual Allowance i.e. the £40,000 or the reduced/tapered annual allowance for high earners (see above), you may carry this forward for up to three years and use it in the current year to allow greater contributions to be paid.
For example, if you have not fully funded your annual allowance in previous three years, you can carry forward the unused portion to the current year.
TAXATION ON PENSIONS
A pension is often referred to as a ‘tax-free’ savings plan; we prefer to refer to it as a ‘tax-deferred’ savings plan.
Taxation on your contributions
When you personally make a payment into a personal pension, you make a net payment, which means your payment is deemed to have been made from (income) taxed income. Therefore, HMRC will add back 20% income tax to your payment to make it a gross payment.
For example, if you earned £100, you would receive £80 after income tax at 20%. If you were to invest £80 into a Lexo pension, the £20 tax is claimed on your behalf and added to your pension, so £100 is saved. i.e. you receive a 25% uplift.
However, if your employer makes these payments into a pension, generally they receive a deduction against their business profits and the pension provider does not claim any income tax back for the member.
Taxation of your pension fund
The money within your pension is not subject to tax: any gains you make are tax-free. No capital gains tax is applied on any growth and no income tax is applied to any interest or dividends.
This is a significant benefit of a pension – a tax-free environment means your capital would grow quicker in a pension, all other things being equal.
Taxation of your personal pension income
When you take an income from a pension, typically 25% of the fund value is payable without any taxation. So whether you wanted to take a lump sum or not, taking a tax-free cash payment of up to 25% is very tax-efficient.
Other funds you take from a pension is taxable as income, and is treated in the same way as any other income you receive. This means you could use your tax-free personal allowance if your income was low, or it would be subject to the relevant rate of income tax.
Your pension income is not subject to National Insurance payments.
Taxation of the pension fund on death
The taxation of the pension fund on death depends when the pension member dies. If the member dies before age 75, all of the fund can pass to the nominated beneficiary without incurring any income tax or capital gains tax. The payment can be a series of regular or ad-hoc payments; or a single lump sum. However, if a single lump sum payment is paid once the money is in the beneficiary’s estate, if the beneficiary were to die soon after, it may be subject to inheritance tax in their estate.
If the pension member were to die at age 75 or after the beneficiary would pay income tax at their marginal rate of income tax i.e. Nil, 20%, 40% or 45%, on any payment they received. They could receive the benefit either as a single payment, regular payments or ad-hoc payments.
If the death benefits were left to a Trust, there would be a 45% tax charge on the money being paid into a trust if death occurred from age 75.