Treat pensions like any other investment

The benefits in pension value and the amount that can be contributed have been drastically reduced by the government in recent years. There are still tax advantages in the relief on contributions, the tax-free roll-up of income and gains in the pension and the tax-free lump sum on retirement, though.

The only limit to the amount an individual can contribute to a pension is their relevant UK earnings in a tax year. An individual can make a contribution of up to 100 per cent of their relevant UK earnings in any one tax year (employer contributions do not count towards this test) or up to £3,600 if their relevant UK earnings are less than this.

However, there is a limit on the amount of tax relief an individual can get back. If the total contribution (including the employer's) is over the annual allowance then a tax charge is applied through an individual's self-assessment tax return, which effectively removes the tax relief.

In the 2011/12 tax year, the annual allowance dramatically reduced to £50,000 from £255,000 the year before, and it is set to decrease further to £40,000 for the 2014/15 tax year. If an individual wishes to make a contribution over the annual allowance, tax relief still may be given. If contributions in the three previous tax years were less than the annual allowance (set at £50,000 for years prior to 2010/11) then the unused allowance can be carried forward to use in the current tax year.

For example, if no pension contributions have been made in the past, a total of £200,000 could be made in the current tax year with tax relief being obtained. One must have been a member of a registered pension scheme in the earlier tax year to take advantage of this.

When looking at the annual allowance, it must be considered that a contribution paid in most circumstances is net of basic rate tax relief at 20 per cent. Therefore, a payment of £40,000 by an individual is a contribution of £50,000 to their pension scheme.

Common pitfalls

For those who have invested wisely, been able to make larger contributions or have a relatively modest pension from a defined benefit scheme, there could be concern over the lifetime allowance, which is currently £1.5m but will be £1.25m at 6 April 2014. The impact of a pension value in excess of the lifetime allowance is that a charge is levied on the excess when it is drawn. The charge depends on how the excess is taken. It is 55 per cent on a lump sum and 25 per cent if drawn by pension. Anyone who is aware that their pension may exceed the lifetime allowance, or is close to it, should seek advice to protect their position.

People may encounter pension recycling without realising it as well. This occurs when a lump sum is received from a pension, but is then recycled into another pension as a contribution. For example, if the money is not needed at that time because of other earnings, the individual may look to obtain tax relief on their earnings by putting extra money back into another pension. This rule also applies where a loan is taken out to make a contribution to a pension scheme with the loan being repaid by a lump sum from a pension.

However, tax at up to 55 per cent can be due if the lump sum is then deemed an unauthorised payment. Care should be taken, therefore, if you are contributing to a pension shortly after receiving a lump sum to provide evidence of the source of the funds being contributed, and the planning for the contribution.

Moving abroad

Income drawn by way of a pension will be taxed at source when paid. This may affect the tax on other sources of income such as a state pension, interest and dividends. When considering retirement and moving abroad it is important to remember that a pension may be taxable in the UK and to ensure that you are correctly taxed in the appropriate country. If double tax treaties are not in place between your country of residence and the UK, there may be a claim to make for double tax relief.

Pensions are a tax-efficient way to save for retirement, but as with any investment, thorough consideration of the implications, alongside careful planning and advice, should form the backbone of a decision.

 

Lucy Brennan is a partner at Saffery Champness

She writes a regular blog on tax and estate planning for Private Client Adviser