Pension savings – tax reliefs

Personal Pensions are prevalent types of ‘registered pension schemes’ that allow members to receive tax relief on contributions and tax-free growth of their funds, subject to certain limits. Here, we outline the rules and options available to maximize tax relief on pension provisions. At AHACCOUNTANTS, we offer expert advice on all tax matters in the Nottingham area.

Types of Pension Schemes

Individuals may receive pensions from two main types of pension schemes:

1. Workplace Pension Schemes
   These can be further classified as:

1. • Defined Benefit Schemes: These pay a retirement income based on final salary and years of service.
   • Money Purchase Schemes: These depend on the amount invested and the performance of the underlying investment fund.

Defined benefit schemes have been declining due to regulatory challenges and costs, with most remaining schemes in the public sector. Each scheme has its own rules within permitted legislation, so professional advice is essential.

All employers must offer a workplace pension scheme due to auto-enrolment legislation, primarily in the form of money purchase schemes. A separate factsheet on auto-enrolment is available.

2. Personal Pension Schemes
   These are privately funded plans, which can also be supported by employers. Like workplace pensions, these are typically money purchase schemes. Self-employed individuals are also eligible to establish Personal Pension plans.

To benefit from tax privileges, all pension schemes must be registered with HMRC, a process handled by the pension provider for Personal Pension schemes.

Tax Reliefs Available

Members of money purchase workplace or personal pension schemes can access various tax reliefs:

• Individuals can contribute and receive tax relief on the higher of £3,600 or 100% of their earnings in any tax year. Tax relief is restricted for contributions exceeding the annual allowance.
• Contributions to a money purchase scheme provide tax relief and tax-free growth within the fund. Employer contributions are typically not taxed for the employee, while employers receive a deduction from taxable profits.

Although there are no caps on total contributions or fund values in pension schemes, tax reliefs are controlled. Each individual has an annual allowance that limits the tax-relieved contributions. Contributions exceeding this allowance incur a tax charge.

Key Features of Money Purchase Pensions

• Contributions are invested for long-term growth up to the selected retirement age.
• Upon retirement (from age 55), the accumulated fund can be converted into retirement benefits, including a tax-free lump sum and taxable income.
• Employer contributions (if applicable) are paid gross directly to the pension provider.

Eligibility

All UK residents, including non-taxpayers like children and non-earning adults, can establish a money purchase pension, though tax relief is limited to gross contributions of up to £3,600 per year.

Methods of Giving Tax Relief

1. Personal Pension Plans: Contributions are generally made net of basic rate tax relief, with the pension provider reclaiming the tax from HMRC. Higher and additional rate relief is claimed via the self-assessment system.
2. Workplace Pension Schemes:
   • Contributions may be deducted net of basic rate tax from the employee’s pay, with the pension provider reclaiming the tax.
   • Alternatively, contributions can be deducted gross from the employee’s salary, reducing their PAYE tax bill, with no further action required for taxpayers.

Salary Sacrifice Arrangement: Employees may consider entering a salary sacrifice arrangement with employers. This allows for gross contributions to the pension provider while reducing the employee’s gross salary, providing full income tax relief and reducing National Insurance contributions.

The Annual Allowance

The annual allowance for tax-relieved contributions increased to £60,000 from April 6, 2023, up from £40,000. Contributions exceeding this allowance are taxed as the individual’s top slice of income.

Carry Forward of Unused Annual Allowance

Individuals can carry forward unused annual allowance for up to three years, allowing higher contributions in certain tax years. For the 2024/25 tax year, unused allowances can be drawn from 2021/22, 2022/23, and 2023/24, provided the individual was a member of a registered pension scheme in those years.

Tapering of the Annual Allowance

Individuals with high incomes may see their annual allowance reduced through tapering. This applies when both ‘adjusted’ and ‘threshold’ income exceed specified limits, with current thresholds set at £200,000 and £260,000, respectively. The minimum tapered annual allowance is £10,000.

Charges for Exceeding the Annual Allowance

If an individual’s contributions exceed the annual allowance, the excess is taxed at their highest income tax rate.

Lump Sum and Death Benefit Allowance (LSDBA)

Individuals with money purchase or certain defined benefit schemes may access a tax-free lump sum when taking pension benefits, typically limited to 25% of the total fund value, capped at £1,073,100 (maximizing to £268,275). Normal income tax applies to other pension income.

Accessing Pension Benefits from Money Purchase Schemes

From age 55, individuals can access pension funds flexibly through:

• A tax-free lump sum of 25% of the fund value.
• Purchasing an annuity with the remaining funds.
• Income drawdown, allowing flexible withdrawals.

Money Purchase Annual Allowance (MPAA)

To prevent tax relief abuses, a reduced annual allowance of £10,000 applies in specific circumstances. The MPAA is triggered when income is drawn from a flexi-access drawdown account or when an uncrystallised funds pension lump sum is received.