Paying into your pension is good...
But don't overdo it
Rules around pensions are complicated and can sometimes even seem to contradict each other. That’s why it’s so important to seek professional advice...
One area that commonly causes confusion is the maximum amount you’re allowed to pay into your pension pot each year. If you put in more than the allowed amount, you will lose the available tax reliefs, on the excess amount, which are one of the main attractions of a pension scheme.
Normally, when a basic tax payer makes a payment into their pension pot, they receive from the taxman an immediate 25% uplift on what they pay in. The annual limit that can be paid in is £40,000, but it’s important to remember that that’s the gross figure, it includes the ‘20% tax relief’. So, the total net contributions an individual can make in a year are £32,000, as the taxman’s £8,000 will bring these up to the limit.
If, by the end of the year, you’ve exceeded this allowance, the tax authorities will ask you to pay back the relief they gave you on the excess. In a sense, you’ve lost nothing, but you have paid money into pension pot which you can’t access until you are 55 for no immediate gain.
It does, however, remain the case, that the money you pay in will benefit from the protection the pension pot gives from income tax and capital gains tax on its future growth. So, in certain circumstances it might be advantageous (i.e where you are already using up your full ISA allowances annually), but such a move should be carefully considered with the benefit of professional advice.
In the event of an over payment, if the amount of annual allowance tax charge to be repaid is less than £2,000, you need to pay it out of your own pocket. If the amount that you owe is more than £2,000, you can request that it be deducted from the pension.
This could be an important consideration for somebody who has no earned income, because for them, the annual limit is just £2,880 net, or £3,600 gross after £720 relief from the government. If you made a gross payment of, say, £5,600, you would face a demand for £400 over payment of tax relief, which cannot come out of the fund as it’s below £2,000. This could be a problem for somebody without earned income.
If you save into your pension through your workplace, the contributions are paid gross, so instead of receiving that 25%, it would never be deducted. But the over payment rules apply and you will be liable for the relief on any over payment. This could happen where monthly earnings fluctuate, perhaps because of commission or overtime. The point is that these rules can affect anyone – employed or self-employed, high earner or someone on the minimum wage. As always, ignorance of the law is no defence.
At Reeves, we had one client: Dan Garner, a higher rate taxpayer who earns £150,000 a year. He’s a busy man and didn’t give his tax and pension affairs the attention they deserve. After the end of the tax year, he was surprised to learn that he owed the HMRC money he’d been overpaid and so came to us for advice. We found that, in the year in question, he’d used up all the existing pension allowance. However, he contributed £8,000 more into his pension and received tax relief of £2,000 making it up to £10,000 gross. Because he’s a higher rate taxpayer, he got more relief with his self-assessment and received a further 25%, or £2,500 back.
He contributed £8,000 net over his allowance. That’s subject to a 45% annual tax charge which is equal to £4,500, so everything he received, including the £2,000 which went straight into the pension pot and the additional £2,500, was demanded back. He had two options: he could pay it from his own pocket or, because it’s in excess of £2,000, he could ask for it to be paid out of his pension.
With savings, tax and pensions, don’t assume that somebody else is taking care of things for you, or that they are taking care of themselves, or, that, because there was no problem in previous years, there won’t be one this year. Keep things under review and, if in doubt, seek advice.
These articles are for information only and are based on specific client circumstances which may be different to yours. No advice should be conferred from the articles. No action should be taken without independent professional financial advice as any actions on your pension may be irrevocable and have a big impact on your income in retirement.