For those who are already aware of what it takes to save for a comfortable retirement, here are five funding tips for pensions on how you can get even more value from your pension savings:
1. The ‘couples’ annual allowance of up to £80,000
Wealthier people whose options are constrained by cuts to both lifetime and annual allowances will be looking for other homes for their savings. But the most tax efficient solution could lie under their nose. How many people know they can pay into their partner’s pension? And, if they do, how many believe the myth that their contributions are capped at £3,600?
The challenge is to raise their awareness that they can top-up pensions for their partners – and not just by £3,600, but up to their partner’s earnings. And their partner will get tax relief on top.
2. Helping children/grandchildren save for their future
Once you have ‘maxed out’ your own and your partner’s pension savings, you could start to build up a pension pot for your children. There’s no minimum age to start a personal pension, though for children under the age of 18 their parents or legal guardian would have to set up the contract on their behalf.
When it comes to paying into a child’s pension, contributions can actually come from anyone, not just the parents. So this could also appeal to grandparents, aunts and uncles to help a child build up a pot of money from an early age, maximising the time for potential growth in a tax free environment.
Where minor children are involved, they can still benefit from basic rate tax relief on contributions up to £3,600 each tax year while UK resident. The parent/grandparent would only have to pay £2,880 to benefit from this, which is less than their IHT annual gift allowance. For adult children, higher rates of tax relief is available depending on their level of earnings. This is regardless of where the original source of the contribution comes from.
Sharing wealth between generations not only helps children/grandchildren prepare for the future, it can also help to reduce the parents/grandparents’ IHT liability. Regular savings may be covered by the ‘normal expenditure out of income’ exemption if the annual exemption is being used in other ways. Ad-hoc payments not covered by the annual exemption will be regarded as potentially exempt transfers (PETs) and will not attract any immediate IHT charges.
From a non-tax perspective, saving into a pension for children/grandchildren can also alleviate any concerns about giving away too much too soon as their child/grandchild won’t be able to access it until later in life. In the meantime, your contributions can help ensure your family member’s pension saving isn’t neglected while they have other more immediately pressing financial commitments.
3. Pension contributions can help with more than just retirement benefits
Reinstate the personal allowance
There are times when making a pension contribution can cost a lot less than you might think. A contribution could restore your income tax personal allowance or your child benefit.
Once an individual’s adjusted net income (broadly your total income from all sources less your pension contributions) exceeds £100,000, the personal allowance of £11,850 (for 2018/19) starts to erode by £1 for every £2 of income over £100,000. Someone earning £123,700 will have no personal allowance and all their income would be subject to tax.
Making a pension contribution will reduce your ‘adjusted net income’ This means someone earning £123,700 who pays £23,700 to their pension would not only receive tax relief of £9,480, but also reinstate their personal allowance of £11,850, saving a further £4,740 tax on their other income, giving an effective tax relief rate of 60% on the pension contribution.
Retain Child Benefit
A similar situation occurs for those claiming child benefit. If the individual or their partner has ‘adjusted net income’ over £50,000, a tax charge is imposed which removes 1% of child benefit for every £100 over that threshold. The full benefit is worth £2,501 (in 2018/19) to a family with three kids, but this will be lost altogether if income exceeds £60,000. But how many are aware that making a pension contribution can ensure that the value of child benefit is saved for the family?
Making a personal contribution to a pension will reduce earnings when calculating income, so as well as giving higher rate tax relief, child benefit could be reinstated. Again, think in terms of a ‘family pension’. There’s no child benefit tax charge if the highest earner has income of £50,000 or less. It may even be as simple as redirecting existing pension saving from the lower earner to the other. But before taking the decision to redirect payments into one partner’s pension, don’t give up any employer matching contributions.
4. A large personal contribution can help avoid the tapered annual allowance
The tapered annual allowance can be a problem for high earners. At worst, an allowance of only £10,000 could either restrict how much they actually pay in, or could land them with a tax charge. But there’s a remedy for those whose ‘adjusted income’ (broadly total income plus any employer contribution) will exceed £150,000. The get out clause is to ensure that the other measure relating to the annual allowance, ‘threshold income’, sits below £110,000.
In most cases, threshold income is simply adjusted income less any employer payments and any individual contributions. If this figure exceeds £110,000, clients should consider what scope they have for making additional personal contributions. This is where any unused carry forward from earlier years can come to the rescue. If there’s enough unused annual allowance to reduce threshold income below the £110,000 line, the current year’s annual allowance of £40,000 will be fully restored. For a higher rate taxpayer, this extra £30,000 annual allowance could amount to a tax saving of £12,000.
5. Is a sacrifice deal the ideal?
The sacrifice route to pension funding is often preferred for certain remuneration streams, typically bonus awards and the taxable element of redundancy payments. If offered, it can be both convenient and tax efficient. The sacrifice of bonus payments will also benefit from NI savings. There is currently no NI on the taxable part of a redundancy payment, although this may change for employers from next year.
But despite this, the sacrifice option should not necessarily be the default choice for high earners. It may not be best route for those caught by the tapered annual allowance. This is because when working out ‘threshold income’, a new sacrifice arrangement does not reduce earnings. But a fully tax relievable personal contribution is a deduction. So actually taking the redundancy or bonus award and making a personal contribution of it could take you below threshold income, restoring the full annual allowance and preventing an annual allowance tax charge.
A Summary from five funding tips for pensions
For a product with an initially simple purpose – to provide income in retirement – pensions have many other aspects that can touch on different areas of someone’s financial life. These points show that contributing to a pension can have other beneficial effects for your clients.
Learn more about how we can help you to Make the Best of your Pension Fund.