INTRODUCTION
If you decide to fund a pension as part of your personal wealth strategy, you may find that your tax adviser’s eyes light up at the thought of the tax advantages available to you. Gordon Wilkinson has outlined the potential benefits of making pension contributions.
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Contributing to a pension fund should always, firstly, be an investment decision. If you decide to go ahead with making pension contributions, then be aware that properly managed pension planning means two key things; one, an opportunity to reduce tax liabilities and two, a requirement to take advice to avoid various pitfalls.
TAX EFFICIENCIES – THE GOOD STUFF
You may already know of some of the following tax-related benefits available to a taxpayer making contributions to a private pension fund:
- Reducing tax on part of your income from 40%, 45% or even 60% to 20%.
- Claiming an additional 25% contribution from the Government.
- Enjoying tax-free growth in the fund.
- Taking a tax-free 25% lump sum on retirement.
- Potentially passing on the value of a fund at death without Inheritance Tax.
But what do the points above actually mean in practice? To demonstrate the benefits of pensions planning, there follows a brief analysis of a recent problem faced by Sarah, a new client of Ryecroft Glenton.
SARAH’S PENSION SOLUTION
Sarah receives annual trading profits of £100k. She has recently purchased a rental property to help support her in retirement and hopes to make £15k rental profit a year. Sarah had a concern about the severe rate of tax that applies when an individual’s total income exceeds £100k.
A payment of £12k to a pension fund in same the tax year as the trading and rental profits are made would have the following effects:
| No contribution (£) | £12k contribution (£) | |
| Rental profits | 15,000 | 15,000 |
| Tax on rental profit | (9,000) | (3,000) |
| Pension contribution | 0 | (12,000) |
| 25% fund increase | 0 | 3,000 |
| After tax – net result | £6,000 cash in hand | £15,000 in a pension fund |
In future tax years, we can monitor Sarah’s income, profits, cash requirement and assess the optimal amount of pension contributions.
POINTS TO CONSIDER – TRAPS FOR THE UNWARY
If you decide that pension contributions could form a useful part of your wealth management and tax mitigation strategies, you may ask “is there a raft of tax legislation to consider?” Of course there is!
Pension planning requires careful thought because a number of restrictions apply and various forms of tax charges exist if you fall foul of these restrictions. The rules relating to income levels can be complex and the following is a brief outline of the main points:
- Lifetime Allowance – a limit on the total value of your pension funds, currently £1,030,000.
- Annual Allowance – a limit on the amount that can be contributed to your pension each year, capped at £40,000.
- Tapered Annual Allowance – if you have ‘adjusted income’ over £150,000, the annual allowance is reduced, to a minimum of £10,000.
- Relevant Earnings – the level of tax relief available depends on you having sufficient ‘relevant UK earnings’ in the tax year. There is a restriction on the amount you can tax-efficiently contribute to your pension if your income in the tax year is insufficient to support the contribution.
SUMMARY
Pension planning is a very powerful tool. However, advice must be taken to ensure that all the relevant factors are considered. If you are interested in finding out more, please speak to your usual Ryecroft Glenton contact.