LEVELS OF CONTRIBUTION CASE STUDY

MAKING GOOD USE OF PENSION LIMITS

As we get closer to the end of the current tax year, it’s a good time to look at your clients’ pension annual allowances. The long-term benefits of maximising allowances via additional contributions or increasing existing regular contributions can, after all, be significant for your clients. 

The first aspect to look at are the limits that restrict pension funding, such as the annual allowance and relevant UK earnings. 

In general, pension allowances work on a use-it-or-lose-it basis, albeit with some scope for carry forward of unused allowances, so it’s good to make regular use of the limits and tax relief.

PENSION FLEXIBILITY

If your clients have accessed their pension flexibly:

The money purchase annual allowance restricts their contributions to £4,000. This limit applies to payments to defined contribution schemes, such as personal pensions and many occupational schemes.

If your clients have not accessed their pension flexibly:

They can usually save much more each year into their pension plans and are subject to the main pension savings limit, the standard annual allowance of £40,000, or lower tapered annual allowance that affects very high earners. All contributions made by the scheme member, their employer and any third parties are tested against this allowance.

For the purpose of this article, we’ll focus on those who are not caught by the money purchase annual allowance.

ANNUAL ALLOWANCES ARE MORE COMPLEX THAN THEY USED TO BE

THE ANNUAL ALLOWANCE RULES HAVE BECOME EXCEPTIONALLY COMPLICATED IN RECENT YEARS

However, the ability to carry forward remains, so if any annual allowance has not been fully used in the previous three tax years, it can be carried forward and added to the annual allowance of the current year, subject to the member meeting the eligibility requirements.

The most complicated aspect, which affects high earners, is the tapered annual allowance. Broadly speaking, this reduces the standard annual allowance by £1 for every £2 of taxable income and employer pension contributions (known as ‘adjusted income’) that exceed £240,000.

The annual allowance, however, cannot reduce below £4,000. More details can be found here.

Our Carry Forward Calculator aims to make dealing with these limits more manageable. It calculates the standard and tapered annual allowances for you when you input a client’s income and pension contributions. To use this calculator, visit the Pension Tools page on the Scottish Widows Adviser Extranet.

CASE STUDY 1 - DINA

Dina, aged 36, earns a salary from full-time employment of £64,700. She has built up a reasonable level of pension savings in her employer’s group personal pension, and is currently paying 5% of her salary, which is matched by an employer contribution of 10%.


She wants to increase her personal contributions to 10% per annum, but this will not be matched by an increase in her employer’s contributions.

Her existing personal contributions are 5% of £64,700: 5% x £64,700 = £3,235.

The proposed increase will take her total annual personal contributions to: £6,470.

As this is less than the amount by which her earnings exceeds the lower level of the higher rate income tax band, higher rate tax relief will be available on her total personal contributions.

The cost to her of increasing her contributions by £3,235 will be £1,941 per annum:

She will increase her net personal contributions by £2,588 (£3,235 x 80%) per annum. And the additional higher rate tax relief will be available when she submits her self-assessment for the tax year.

Taking all tax reliefs into account, the annual increment of £3,235 gross will ultimately cost her just £1,941:

Net cost after basic rate relief: £3,235 x 80% = £2,588.

Net cost after receiving higher rate relief: £2,588 - £647 (20% x £3,235) = £1,941.

She also has enough annual allowance in the current tax year to easily cover her total personal and employer contributions.


The existing and increased contributions can be projected forward using Scottish Widows Top Up Tool, giving you an idea - based  on a number of assumptions - what the client’s contributions might grow to by the time they reach their anticipated retirement date.

To access the Top Up Tool click here

This information is for UK Financial Adviser use only and should not be distributed to or relied upon by any other person.

CASE STUDY 2 - CLINT

Clint, aged 40 years old, is a self-employed builder. He has no pension savings other than £20,000 held in a contracted out personal pension from 2003. Having recently secured  a long-term construction contract, he has a large amount of cash to invest in a pension.


He has a 30th April year end, so he already knows his net trading profits for the current year which are £85,300. He wants to pay £60,000 into a new personal pension. 

This will be grossed up at 20% to £75,000 (£60,000 / 80%), which is within his relevant UK earnings for the tax year. He also has enough annual allowance plus carry forward to easily cover the contribution (the personal pension confers eligibility for carry forward from previous tax years). 

He sets up a new personal pension and pays the net contribution to the pension provider. As a higher rate tax payer he will also be eligible for some higher rate tax relief, but this is limited to the additional amount of tax he pays at the higher rate:

(£85,300 - £50,270) x (40% - 20%) = £7,006.

The additional higher rate tax relief will be available when he submits his self-assessment. It will be reflected in the final balancing payment he makes for the year.

Taking all tax reliefs into account, the £75,000 contribution has ultimately cost him just £52,994:

Net cost after basic rate relief: £75,000 x 80% = £60,000

Net cost after receiving higher rate relief: £60,000 - £7,006 = £52,994


The existing and increased contributions can be projected forward using Scottish Widows Top Up Tool, giving you an idea - based  on a number of assumptions - what the client’s contributions might grow to by the time they reach their anticipated retirement date.

To access the Top Up Tool click here

This information is for UK Financial Adviser use only and should not be distributed to or relied upon by any other person.