Understanding the Current Tax Relief Position on UK Pension Contributions

The tax relief system on UK pension contributions is designed to encourage individuals and businesses owners to save into pensions by offering generous incentives. For many, it’s one of the most effective ways to reduce their taxable income and/or taxable profits while ensuring a more secure financial future. However, understanding the nuances of the current tax relief structure is crucial for maximising its benefits. In this blog, we’ll explore the various aspects of tax relief on pension contributions.

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1. How Pension Tax Relief Works

In the UK, pension tax relief allows you to contribute to your pension pot using pre-tax income for self-employed or partnership business or pre-tax profits for companies. Essentially, this means that the government contributes to your pension by giving you back the tax you would have paid on the income you’ve contributed, or reduces the profit on the money paid into a UK registered pension. The key benefit here is that it reduces your overall tax liability.

The tax relief you receive on your pension contributions depends on your income tax rate:

Basic Rate Taxpayers (20%): For every £8,000 you contribute to your pension, the government tops it up with an additional £2,000 so £10,000 goes into your pension pot.

Higher Rate Taxpayers (40%): You can claim back an additional £2,000 from HMRC, either through your tax return or by adjusting your tax code. This means the effective cost of a £10,000 contribution is only £6,000.

Additional Rate Taxpayers (45%): Similar to higher rate taxpayers, you can claim back £2,500, making the effective cost of a £10,000 contribution just £5,500.

Ltd Companies: relief at the same rate as your corporation tax, so if you pay corporation tax at 25%, a £60,000 pension contribution effectively costs just £45,000.

2. The Annual Allowance

While the government encourages pension saving through tax relief, there are limits on how much you can contribute each year before incurring a tax charge. The Annual Allowance is the maximum amount you can contribute to your pension each year with the benefit of tax relief personally. For most people, the Annual Allowance is £60,000, but it can be lower for high earners or those who have already started drawing from their pension. For company pension contributions, the amount paid needs to be a “wholly & exclusively commercial” transaction that reflects the overall remuneration package of the recipient, so always useful to agree this amount with your Accountant before going ahead

Tapered Annual Allowance: If your adjusted income exceeds £260,000, your Annual Allowance could be reduced (or tapered). For every £2 of income over £260,000, your allowance is reduced by £1, down to a minimum of £10,000.

Money Purchase Annual Allowance (MPAA): If you’ve accessed your pension under the new pension freedoms, your Annual Allowance might be reduced to £10,000, known as the MPAA.

Contributions over these allowances will incur a tax charge, which effectively removes the tax relief on the excess amount.

3. The Lifetime Allowance (LTA)

Before it was scrapped, the LTA stood at £1,073,100 (2023/24). This meant that any amount above the LTA would be taxed as income at the marginal tax rate when withdrawing. Marginal rate of tax is the highest tax bracket into which your income falls.

So, a pension pot worth £1.2 million, would have been £126,900 over the LTA. This is the amount that you would’ve been taxed at either:

• 55% if taken as a lump sum; or
• 25% if taken any other way, for example to buy an annuity or via drawdown.

On 6 April 2024, the lifetime allowance (LTA) was abolished and a new regime for the taxation of lump sums and lump sum death benefits introduced.

The regime created a new (tax free) ‘lump sum allowance’ (LSA) of £268,275 and a new ‘lump sum and death benefit allowance’ of £1,073,000 (LSDBA)

Unless one of the ‘transitional’ protections are in place, then the LSA / LSDBA dictate the maximum amount of income tax free payments that can be drawn from a pension in certain circumstances, so it’s crucial to have the right advice when considering the death benefits of pensions or accessing the fund before retirement.

4. The State Pension and its Impact on Tax Relief

While the state pension is an essential component of retirement income, it operates independently of the tax relief you receive on personal pension contributions. The current full state pension is currently £221.20 per week, which equates to just over £11,500 per year. As this amount is presently below the personal allowance threshold, most people won’t pay tax on their state pension.

However, when combined with other retirement income, including private pensions, you might exceed your personal allowance, leading to income tax liabilities. Understanding how your overall retirement income will be taxed can help you make more informed decisions about your pension contributions today.

5. Changes to Pension Tax Relief and Future Considerations

Pension tax relief has been a subject of political debate for many years, with various governments considering reforms to reduce the cost to the Exchequer.

Some proposals have included:

Flat-rate relief: Replacing the current system with a flat rate of relief for all taxpayers, regardless of their income tax band.

Lowering the Annual or Lifetime Allowance: Further reductions in these allowances could affect higher earners and those with significant pension savings.

Staying up-to-date with these developments and working with a financial advisor can help you adapt your retirement strategy to any changes in the tax relief landscape.

6. Practical Steps to Maximise Pension Tax Relief

Here are some practical tips to make the most of your pension tax relief:

Maximise Employer Contributions: Use surplus cash/retained profits in the company to make pension contributions.

Plan for the Tapered Allowance: High earners should calculate their adjusted income and plan contributions accordingly.

Claim Additional Tax Relief: Higher and additional rate taxpayers should ensure they claim all available tax relief through self-assessment.

The current tax relief system on UK pension contributions offers significant incentives for saving tax as well as building a meaningful fund towards retirement. It would be sensible to understand the opportunities available to you before the next budget statement on 30 October.

Contact us at enquiries@fortus.co.uk, or call us on 01904 558 300 to discuss your pension needs.