It’s easy to forget many of the basics of financial advice
As the tax year end approaches, we’ve identified 10 good reasons for your clients’ to pay into a pension now.
These are all based on what we know, not speculation about what might happen in the future.
10 good reasons to pay into a pension this tax year
1. Get personal tax relief at top rates
For those clients who are higher or additional rate tax payers this year, but are uncertain of their income levels next year, a pension contribution now will secure tax relief at their highest marginal rate. Typically, this may affect employees whose remuneration fluctuates with profit related bonuses, or self-employed individuals who have perhaps had a good year this year, but are not confident of repeating it in the next. Flexing the carry forward and PIP rules gives scope for some to pay up to £240,000 tax efficiently in 2013/14.
For example, an additional rate taxpayer this year, who feared their income may dip to below £150,000 next year, could potentially save an extra £5,000 on their tax bill if they had scope to pay £100,000 now.
2. Pay employer contributions before corporation tax relief drops further
Corporation tax rates are falling, expecting to reach 20% by 2015. So companies should consider bringing forward pension funding plans to benefit from tax relief at the higher rates. Payments should be made before the end of the current business year, while rates are at their highest.
For the current financial year the main rate is 23%. This drops to 21% for the new financial year starting 1st April 2014.
3. Sweep-up unused allowance from 2010/11
- Unused pension annual allowance from 2010/11 must be used this tax year – or it’s lost forever. For a 40% taxpayer, this could mean a missed opportunity to save up to £50,000 at a net cost of only £30,000.
- Clients already in their 2014/15 PIP, who still have unused allowance from 2010/11, could start a new contract to sweep this up. A new contract started this tax year automatically has a PIP ending on 5 April 2014 i.e. in the 2013/14 tax year.
- And the transitional provisions for 2011/12 PIPs that started before 14 October 2010 mean some clients may have more carry forward available than may appear on the surface. They could still have carry forward from earlier years despite having paid up to £255,000 for 2011/12.
4. Make the most of the £50,000 pension allowance
- The annual allowance drops to £40,000 from the new tax year.. But the PIP rules mean that some clients are paying towards this limit already.
- Carry forward for the three previous years back to 2010/11 will still be based on a £50,000 allowance. But over time, the new £40,000 allowance will come into the calculation and dilute what can be paid. Up to £200,000 can be paid to pensions for this tax year without triggering an annual allowance tax charge. By 2017/18, this will drop to £160,000 – if the allowance stays at £40,000. And don’t ignore the risk of further cuts.
5. Use next year’s allowance now
- Some clients may want to pay more than their 2013/14 allowance – even after using up all their unused allowance from the three carry forward years. To get round this, they can pay against their 2014/15 before 6 April by closing their 2013/14 PIP early. This opens up their 2014/15 PIP – allowing an extra £40,000 to be paid in this tax year.
- This might be good advice for a client with particularly high income for 2013/14 who wants to make the biggest contribution they can with 45% tax relief. Or perhaps a company who has had a particularly good year and wants to reward directors and senior employees and reduce their corporation tax bill.
6. Recover personal allowances
- Pension contributions reduce an individual’s taxable income. So they’re a great way to reinstate the personal allowance and the age related element of personal allowance.
- Personal allowance. For a higher rate taxpayer with taxable income of between £100,000 and £118,880, an individual contribution that reduces taxable income to £100,000 would achieve an effective rate of tax relief at 60%. For higher incomes, or larger contributions, the effective rate will fall somewhere between 40% and 60%.
- Age related element of personal allowance. For a client between the age of 65 and 74, a pension contribution reducing taxable income to below £26,100 will reinstate the age related element of their personal allowance. The full amount of the age related element is £1,060 in 2013/14 – saving the client £212. But the allowance is wiped out once income exceeds £28,220.
7. Avoid the child benefit tax charge
- An individual pension contribution can ensure that the value of child benefit is saved for the family, rather than being lost to the new child benefit tax charge. And it might be as simple as redirecting existing pension saving from the lower earning partner to the other.
- The child benefit, worth £2,449 to a family with three kids, is cancelled out by the tax charge if the taxable income of the highest earner exceeds £60,000. There’s no tax charge if the highest earner has income of £50,000 or less. As a pension contribution reduces income for this purpose, the tax charge can be avoided. The combination of higher rate tax relief on the contribution plus the child benefit tax charge saved can lead to effective rates of tax relief as high as 64% for our family with three children.
8. Sacrifice bonus for employer pension contribution
- It’s bonus season again. Sacrificing bonus for an employer pension contribution before the tax year end can bring several positive outcomes for the client.
- The employer and employee NI savings made could be used to supercharge pension funding, giving more in the pension pot for every £1 lost from take-home pay. And the client’s taxable income is reduced, potentially recovering personal allowance or avoiding the child benefit tax charge.
9. Boost SIPP funds now before moving to flexible drawdown
- If your client is considering a move to flexible drawdown in the new tax year, the remainder of this tax year is their last opportunity to make tax efficient pension savings.
- Remember, no pension contributions can be made in the year flexible drawdown starts. And contributions in the tax years after starting flexible drawdown all suffer the annual allowance tax charge.
10. Fund and protect above the new £1.25M LTA
- With the lifetime allowance set to fall to £1.25M from April 2014, there will be some new clients now weighing-up the pros and cons of electing for the new ‘fixed protection 2014′ to lock into a £1.5M LTA. But they’ll have to stop paying into pensions after 5 April 2014. So this only leaves a short window to maximise their tax efficient contributions and build a bigger retirement pot to protect.
- In addition to fixed protection, clients will also be able to choose ‘individual’ protection. This will give an LTA of between £1.25M and £1.5M, but unlike fixed protection, further savings can be made. A fund of £1.25M or more as at 5 April 2014 is needed to choose this option, and so further saving before this date may be needed to ‘get over the line’.
