A personal pension is essentially a savings scheme that allows you to build up the pension pot you need to provide an income in retirement.
But there is an important difference between a pension and most other ways to save. With most forms of saving (with the exception of ISAs) the taxman will actually take a cut of the interest your savings earn, once they pass a certain level. This is knows as Capital Gains Tax (CGT), and the personal annual CGT allowance for 2018/19 is £11,700.
With pension savings, the taxman will actually add to what you save.
This is because the government wants us to prepare financially for our old age. To encourage us, and to make pension savings more worthwhile, they provide tax relief.
This tax relief means that for every pound a basic rate taxpayer saves in their pension pot they will in effect only need to pay in 80p. Things are even more rewarding for higher rate taxpayers who pay in just 60p for the same benefits.
It is this tax relief that makes pension saving so rewarding. In fact, for most of us it could potentially be the best investment we will ever make.
However, it is so rewarding the government has had to set limits on what we save, to ensure that the exchequer can retain enough funds to run the country.
The pension allowances
These limits are collectively known as pension allowances and represent the maximum we can invest in our pensions.
The first is the annual allowance. This is currently £40,000, or your entire income each year, whichever is the smaller.
This sounds like a large sum, and most of us would be unable to make that level of contribution. If you did – perhaps for the last year of your working life – as a higher rate taxpayer (allowing for tax relief of 40%), it would mean boosting your pension pot by a gross amount of £56,000.
But whether or not we can make the full annual contribution, there is another allowance which will limit how much you can save in your pension pot.
The Lifetime Allowance, or LTA is the maximum you can put into your retirement savings without incurring a tax charge. It is linked to inflation, and for the current tax year it is £1,030,000, with this rising in the 2019/2020 tax year to £1,055,000.
If you believe you will go over your LTA you may find yourself hit by tax penalties, and it is important to get some expert help without delay.
You want to use your allowances to the full to make the most of your pension – but you need to avoid running over the limits, to avoid being hit by tax penalties. It can be a fine line, and getting help is essential.
As always when tax is concerned, there are complications. The government limits tax relief for people on the largest incomes. The taper as it is known affects people with an income over £110,000. If their ‘adjusted’ income, which includes things like employer’s pension contributions is over £150,000, their entitlement will be tapered off. For every £2 of income they have over £150,000, their annual allowance is reduced by £1.
The maximum reduction will be £30,000. So, anyone with an income of £210,000 or more will see their annual allowance fall to £10,000.
Get some help with your allowances
Building the pension pot you want will be easier if you make the most efficient use of your allowances now and have plans in place if you are in danger of exceeding any of the limits.
There are ways to mitigate the impact of the taper, and there are certainly ways to keep building your wealth if you have already built up the maximum pension pot.
At Continuum, we will be happy to work with you to provide the solutions.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment strategy, you should seek independent financial advice before embarking on any course of action.
Levels and basis of reliefs from taxation are subject to change and depend upon your personal circumstances.
The value of investments can fall as well as rise and you may get back less than you invested.