Will I pay more tax if I invest in my pension?
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Phil Beck is an Independent Financial Adviser with Smith & Pinching, Chartered Financial Planners. Here he advises on Annual Allowances for pension contributions.
I am fortunate enough to be an additional rate taxpayer and have just paid the final instalment on my mortgage so have spare income. I’m in my fifties and am beginning to think ahead to retirement. I’d like to put significant amounts into my pension but I believe there are tax implications if I put too much in. Is this the case?
Phil Beck of Smith & Pinching responds:
There are two specific allowances that you need to bear in mind if you want to build a large pension fund for your retirement. The first of these is your Annual Allowance for pension contributions. This allowance is the total you can put into your fund in a given tax year and benefit from tax relief. It stands at £40,000 for the 2020/21 tax year – or 100pc of your earnings for those who earn below £40,000.
However, a high income will reduce your Annual Allowance, on a sliding scale. The rules are quite specific but you need to understand two elements that are key to working it out. The first of these is your Threshold Income, which is your total income from all sources less certain allowances and less any personal contributions you make to a pension. Broadly speaking, if your Threshold Income totals more than £200,000 you are likely to fail this initial test and you will then need to look at your Adjusted Income. This is different from your Threshold Income as, this time, pension contributions made by your employer are included.
If you fail the Threshold Income test and your Adjusted Income exceeds £240,000 (2020/21 tax year), then your Annual Allowance will be tapered by £1 for every £2 you are over the £240,000. The maximum reduction that can be applied is £36,000, resulting in an Annual Allowance of £4,000. This is reached when your Adjusted Income is £312,000.
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If you’ve started taking flexible withdrawals from your pension savings, whatever your income levels, then the Money Purchase Annual Allowance of £4,000 applies. Anything you put into your pension that exceeds the Annual Allowance applicable to you will be subject to a tax charge.
The other allowance to bear in mind is your Lifetime Allowance for Pensions. This currently stands at £1,073,100 and is set to increase annually. If your total pension savings exceed this figure at certain trigger points – when you start to take benefits from your pension savings, turn age 75 or transfer your pension overseas – then you will be subject to a tax charge.
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This is a hugely complex area and there are some planning opportunities here, so do talk your strategy through with an Independent Financial Adviser to see if you can use entitlements such as carrying forward unused Annual Allowance from previous years. Remember: there are other tax-efficient investment opportunities you could consider if you would breach the Annual Allowance with additional contributions.
Any opinions expressed in this article do not constitute advice. The value of your investment can go down as well as up and you may get back less than the amount invested. They assume the 2020/21 tax year and may be subject to change.
For more information please visit www.smith-pinching.co.uk