When is the right time to top up your pension fund? Let’s face it; it probably isn’t at the top of anyone’s to do list. But for wealthy individuals that time is probably right now. Further cuts to how much can be put away will be introduced from April. And this comes at a time when a review of pension tax relief could signal the end of tax relief at higher rates. All this adds a sense of urgency to make sure you’re getting the most out of pension funding opportunities.
Before you start, it’s important to remember that your pension is an investment – your payments are invested in your chosen funds and the value can go down as well as up and you may get back less than what you put in.
New pension freedoms
Recent changes have revolutionised how you can take your pension savings. They’re now far more accessible than ever before and allow greater opportunity to provide a legacy from any funds which are not spent during retirement. And this should increase their appeal as age old barriers such as limited access and loss of fund on death, have been removed.
Once you reach 55 you can take out what you want, when you want it. You just need to take into account the tax implications when you do.
Pensions are also far more inheritable than ever before. Unused pension funds can now be passed on to future generations as either a lump sum or as pension funds that your loved ones can draw on whenever they choose to. And if you die before age 75, any payments will be tax free in the hands of your beneficiaries.
Bear in mind that all this new flexibility is only available to those with defined contribution pensions. These are pensions where your contributions go into your own separate pension fund to be invested. It is worth checking whether your existing pension scheme can facilitate these new options as some pension providers may not have the systems in place to offer them. It may require a transfer to a modern pension scheme to access the full range of benefits now on offer.
The new flexible access isn’t available to defined benefit pensions – occupational pensions which pay out a fixed amount linked to your salary.
The tax benefits of pension saving
Factor in tax relief on contributions, tax efficient investment returns and the ability to take a quarter of the fund tax free; and it all adds up to the most tax efficient way of saving for retirement.
If you have a personal pension, the amount you actually pay is boosted by the addition of tax relief. For example, to make a £40,000 contribution to your pension could actually involve you writing a cheque for just £32,000. You pay the net contribution, and your pension provider secures the 20% tax relief top-up from the government, so the end result is £40,000 paid into your pension.
And don’t forget that any higher or additional rate tax relief will need to be reclaimed through your self-assessment. This could knock a further £8,000 (or £10,000 for additional rate taxpayers) off your annual tax bill.
It’s important to note, this is our understanding of the current laws and tax rules but things can change, like the restrictions on contributions described below. Just remember that your personal circumstances also have an impact on tax treatment so take advice where needed.
Cuts to allowances
Restrictions are to be introduced to further limit how much wealthy individuals can pay into their pension.
From 6 April 2016, once your earnings exceed £150,000 the contribution limit will begin to drop from £40,000 to a minimum of £10,000 for earnings over £210,000.
At the same time the lifetime limit on how much can be accumulated in your pension will drop from £1.25m to £1m. But if you expect that your funds will be greater than £1m at retirement you can protect your pension savings from tax charges for breaching the cap. But protection could be at the expense of making any further contributions.
These cuts to valuable pension funding allowances can be the signal to accelerate future pension funding plans and bring forward contributions. Paying contributions this tax year will allow contributions to be tested against the current annual allowance and also the option to protect them against lifetime allowance tax charge after April if necessary.
How to boost funding this year
An added bonus this tax year is that it may be possible to pay more than the £40,000 into your pension. In moves to make pension funding limits easier to understand and to have both tax relief and fund limits aligned to the tax year there is a special allowance which has the potential for as much as £80,000 to be paid for the 2015/16 tax year if you had already contributed before the 9 July 2015.
If you haven’t made use of your annual pension allowances for the previous three years these can still be rolled up and paid in one large contribution this year. This could see you being able to pay an extra £140,000 in addition to the balance of your current year’s allowance. But you will need the earnings this year to support the higher contribution.
Despite efforts to simplify pension funding rules, it still remains a complex area. Seeking advice on how to make the most out of your pension savings and topping up when the time is right, is time well spent.
Article by; David Downie of Standard Life
Every person’s circumstances will be different and the information in this article should not be considered advice. If you have any questions about your personal circumstances, you should consider speaking to a financial adviser.