Who can invest in a pension?
Tax-relievable pension contributions can be made for an individual who is UK resident (or has been in the previous 5 years and has a UK pension). Or someone who is either employed by the Crown or who is the spouse or civil partner of someone employed by the Crown.
Contributions into a pension can be made by the individual, an employer or a third party (i.e. a parent). There are no age limits, and pensions can be taken out for minors. However, in practical terms, it is not possible for someone over age 75 to make a personal contribution to a pension and receive tax relief on it (although their employer could, if applicable).
How much can an individual contribute to a pension?
Personal contributions made by an individual are unlimited. However, there is a limit on the amount of gross contributions an individual can pay each year and benefit fully from tax relief.
Any individual under the age of 75 will benefit from tax relief on individual contributions but this is restricted to the higher of £3,600 or 100% of relevant UK earnings.
Contributions can be made on a regular basis, as lump sums, or as a combination. Regular contributions can usually be stopped, increased, or decreased at any time.
What are relevant UK earnings?
While we will not cover all the various types of relevant UK earnings for the purpose of pension contributions, it is important to highlight some key income sources that would not qualify.
Relevant UK earnings typically include employment income, income derived from a trade, profession or vocation, taxable redundancy pay, sick pay, taxable benefits in kind, profit related pay and permanent health insurance paid via an employer.
Most notable are the types of income that would not qualify as net relevant earnings. This includes investment income, dividends and property rental income.
How does Tax Relief Work?
Your tax relief depends on how much you pay in, and the highest rate of income tax you pay in a tax year.
For nil or basic-rate taxpayers, basic rate tax relief is applied at 20%. For example, if you were to make a personal pension contribution of £100 net, you’ll receive a further £25 in tax relief. This would provide a total pension contribution of £125 at a net cost of £100.
If you’re a higher or additional rate taxpayer, you will be able to claim tax relief at your marginal rate income tax. The application of how to claim this additional tax relief will vary depending on the method of contribution.
Most personal or group personal pensions, will operate a ‘relief at source’ approach which means contributions are from net pay and basic rate tax relief is applied to your pension plan. You can then claim back additional tax relief via your self-assessment, and this will be offset against your income tax bill.
Some workplace pensions may take your contributions from earnings before tax is deducted. If you’re in one of these schemes, you’ll automatically receive all the tax relief you’re due up front – unless you’re earning below the personal threshold of £12,570.
In addition to the limit on personal tax-relievable contributions, the maximum total contributions that can be made for an individual from all sources in a tax year without suffering a tax charge is the Annual Allowance of £40,000. Contributions in excess of the Annual Allowance will be subject to an Income Tax charge based on the individual’s personal tax position.
This Annual Allowance is restricted by £1 for every £2 that an individual’s ‘Adjusted Income’ exceeds £240,000 (if their ‘threshold income’ exceeds £200,000). However, the Annual Allowance is not reduced further than £4,000.
It is possible to carry forward unused Annual Allowance from the previous three tax years assuming you had a pension plan in those years and provided you have not drawn any benefits flexibly from a Defined Contribution (money purchase) pension scheme. This can negate any potential tax charge if you exceed the annual allowance.
When you have flexibly accessed a Money Purchase pension, the Money Purchase Annual Allowance will apply to future money purchase contributions. This is £4,000 in the 2022/2023 tax year.
If the total value of your pension benefits exceeds your Lifetime Allowance which is currently £1,073,100. The excess will be subject to a tax charge of up to 55% if taken as a lump sum. If the excess over the Lifetime Allowance is designated for income the tax charge is 25% with any income subsequently taken taxed at marginal rates of tax. Increases to the Lifetime Allowance have been frozen until April 2026 having previously increased annually in line with the Consumer Price Index (CPI).
It is sometimes possible to elect for lifetime allowance protection for your pension funds, which can result in a higher Lifetime Allowance being applied. You should take advice as to whether protection is applicable to you.
For any other enquiries about your retirement, don’t hesitate to contact us on 01903 534587.