Following the government’s recent announcement of a National Insurance and Dividend Tax rise, as well as a suspension of the State Pension triple lock, tax bills are set to increase for many from April next year.
Under current rules, taxpayers stop making National Insurance contributions when their State Pension kicks in. By 2023, however, the changes mean that around 1 million working pensioners will pay National Insurance contributions on their earnings for the first time.
Add to this the chancellor’s announcement in his March budget of freezes to the pension Lifetime Allowance (£1,073,100), the Capital Gains Tax allowance (£12,300), and the Inheritance Tax nil-rate band (£325,000), and the need to be tax-savvy when taking your pension is more important than ever.
Here are three pension tax traps to avoid and how to make the most of pension tax breaks, plus how Hartsfield Planning can help.
1. Make the most of pension tax relief
According to a recent survey, UK adults would view pensions more favourably if they understood tax relief. The results of the survey, published in Money Marketing, suggest that 25% of people would increase their contributions if they had a firm grasp of the concept.
Tax relief is added to the pension contributions you make. As a basic-rate taxpayer, each £100 pension contribution costs you just £80. This is because your gross income is taxed at 20% but pension contributions are free of tax. The government effectively pays your tax back.
If you are a higher-rate taxpayer (paying tax at 40%) you can claim the additional 20% through your self-assessment, meaning that your £100 contribution costs just £60. The cost of a £100 contribution for an additional-rate taxpayer (45%) is just £55.
As well as tax relief on contributions, you can claim 25% of your pension pot as tax-free cash on retirement.
2. Getting to grips with the pension Annual Allowance
The Annual Allowance is a cap on the amount you can pay into your pensions annually, while still benefiting from tax relief.
For the 2021/22 tax year, the allowance stands at £40,000 (or 100% of earnings if lower). That means you can contribute up to £40,000 each year and still receive tax relief on your contributions.
However, other allowances might apply.
If you are a high earner, you might be hit by the Tapered Annual Allowance. If your threshold income exceeds £200,000 and your adjusted income is more than £240,000, the taper is likely to apply.
If it does, your Annual Allowance reduces by £1 for every £2 your income exceeds the threshold amount, down to a minimum of just £4,000. As a high earner, managing your tapered allowance can be complex. Hartsfield Planning can help, so get in touch.
Your Annual Allowance can also reduce if you access your pension using certain flexible options.
You might find that you trigger the Money Purchase Annual Allowance (MPAA), which reduces the amount you can contribute to your remaining pensions – while still getting tax relief – down to £4,000.
If you are looking to access pension funds while continuing to contribute to other plans you hold, you will need to be bear the MPAA in mind and choose your retirement options carefully.
3. Understanding the Lifetime Allowance
The Lifetime Allowance (LTA) is the amount you can withdraw from pension plans you hold without triggering an LTA charge.
Introduced in 2006, the LTA peaked at £1.8 million. In his March 2021 Budget, the chancellor froze the LTA at its current level of £1,073,100 until at least 2026.
When you withdraw funds from your pension in certain ways, your withdrawal will be tested against the LTA to see if a charge applies. If your funds exceed the allowance, you will be liable for a charge of 55% on any excess you take as a lump sum and 25% if the excess is taken as income.
Just last month we looked at the Lifetime Allowance in more detail, including how to fit it into your pension planning, and how you might protect yourself against it.
Get in touch
At Hartsfield Planning, our team of financial services professionals can provide you with the expert advice you need to make your retirement dreams a reality.
Whether you are still saving for retirement, looking to manage your pension withdrawals, or beginning to think about the inheritance you intend to leave behind, we can help you build a tax-efficient plan that is personal to you. Get in touch and find out how our team of expert planners can help
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.