Personal Pension Contributions Can Save Tax
Paying into a pension is often one of the easiest ways to
reduce your personal tax liability. If you have a limited company, please see our article here before considering making any contributions
personally. This article is primarily aimed at those in employment, who are not
making contributions through their own company, or who are self employed.
Please note that Sherwin Currid cannot give financial advice and can
only advise on the tax implications of making a pension contribution. We can refer you to a financial advisor if required.
Are you a
higher-rate taxpayer making pension contributions?
If you are an employee and a higher-rate taxpayer, you
should check if the pension deductions on your payslip are giving you immediate tax relief (see below 'Understanding the pension deduction on your payroll'). If they are not under a 'net pay arrangement', you may be significantly
overpaying tax. In addition, if you make any extra pension contributions from your
own bank account, you must report it on your tax return to obtain full tax relief.
Self employed and think you will be a higher rate taxpayer?
Making a pension contribution could significantly reduce your marginal rate of tax in the tax year that you make them. If you are not sure of your profits we can help estimate an appropriate figure for you. This must be done before the end of the current tax year 5 April 2025 to reduce your 2024/25 tax bill. Contributions made in the current tax year cannot change your marginal rate for 2023/24.
Interaction with child benefit
If you are claiming child benefit, your income is effectively reduced when your make a personal pension contribution and can significantly save tax. If you are claiming child benefit and your income is within the tapering thresholds please also read our article
here for 2023-24 and
here for the current 2024/25 tax year after the recent changes.
Tapered allowances apply for high earners
If you earn over £200,000, your
annual allowances may be tapered, so please seek professional advice specific to
you.
Rules on
pension contributions
Tax relief is only permitted on pension contributions if:
- You
are under 75
- You
are UK resident
- You
have sufficient 'relevant earnings'
- You
are ordinarily limited to £60,000 in contributions a year
Relevant
earnings & statutory minimum contribution
Relevant earnings are income derived from a trade,
profession or vocation. Typically employment or self-employment. Dividends,
interest and rental income, do not qualify as relevant earnings. This means if
you only have dividends or rental income, you would only be able to make personal pension contributions up to the statutory maximum of £2,880 for that tax year (£3,600 gross).
Employers may pay employees' pension contributions
instead of salary, so someone can use up their allowances even if they have a
low wage. This is typically seen where the employer is the individual's
personal company.
Please find below several different illustrations for reference:
Taxpayer A has £30,000 dividend income from shares in a large oil
company and is unemployed. They are limited to £2,880 a year. HMRC would top
this up to a gross amount of £3,600.
Taxpayer B earns £60,000 a year as a consultant in full-time employment. The individual pays a net contribution of £8,000, and HMRC tops this up with
£2,000 to a gross amount of £10,000. The employer also pays an
employer contribution of £5,000. The remaining £45,000 of Taxpayer B's pension
contribution allowances are carried forward to future years (subject to the usual limits).
Taxpayer C earns £10,000 a year in sole trade profits. They pay a
net contribution of £8,000, and HMRC tops this up with £2,000. They have no
allowances to carry forward.
Taxpayer D is a director of their own company. They receive £10,000 in
salary and £40,000 in dividends. While they are restricted to making £10,000 in
pension contributions as Taxpayer C above, their employer (i.e. their own
company) can pay up to the statutory amount. The director, Taxpayer D, decides
to pay the Company employers contributions of £60,000 into his pension.
Net/Gross - How do I work out what to actually pay in?
Since HMRC top up any personal pension contribution you must only pay in the net. So if you wish to personally pay in the full allowance of £60k for 2024-25 you would actually only pay in £48k.
To work out the exact amount dividend your gross by 1.25. So if you want your pension increased by £17,000 you would only pay in £17,000/1.25 = £13,600.
Understanding the pension deduction on your payroll
There are three types of pension deductions and it is not always clear which one you have:
1. Net pay arrangement
Under a net pay scheme, all of the employee contributions are deducted from the employee’s gross salary and tax is calculated after the deduction has been made, or 'net' of the pension deduction. This means full tax relief is given at source.
2. Salary sacrifice
Many employers run their employees' pension schemes via a
salary sacrifice arrangement because it saves you and them National Insurance
contributions. The portion of the salary given up to a pension is not subject to NIC. You should
note that sacrificing part of your salary may affect future calculations of
pensions, redundancy pay and other benefits such as statutory maternity pay.
The salary sacrifice arrangement cannot reduce your cash pay below the relevant
national minimum wage or national living wage rates. It is most suited to employees who pay tax and less suited to low income or part time employees.
How do I know
if my pension deductions are via salary sacrifice?
One quick way is to look into your pension fund. If it
only has employer contributions listed, you likely have salary sacrifice.
Your sacrificed salary is treated as if you never received it, and the employer
has paid it straight into the pension. If the pension statement shows employer
and employee contributions, please provide us with these details.
3. Relief at source
Under relief at source schemes the employer only deducts 80% of the contributions leaving HMRC to top up the rest directly into the pension fund. If you have are a higher rate tax-payer you will need to get full relief via your tax return.
Carry forward
allowances
Any unused allowances can be carried forward for up to
three years if the taxpayer had a registered pension scheme open during that
time.
Personal pension contributions
Please be aware that if you are making personal pension contributions from your own bank account, you will only be able to obtain tax relief on pension contributions up to the level of your PAYE earnings. Most sources of income - such as dividends, interest and property income - do not count as earnings for pension purposes. This generally leaves employment income, which tends to be relatively low for limited company director-shareholders for their tax efficiency.
Reduced pension
allowances for high earners
Your annual pension allowances may be tapered if you have
income above £200,000. You should contact your accountant or financial advisor
before making any contributions as this can be complex.
Threshold income and adjusted income
Threshold income is
usually your net salary, other income like dividends, interest,
property income, and your salary sacrifice pension from your employment.
If your threshold income is below £200,000 you have the full annual
allowance. If it isn't below £200,000, then we then look at adjusted
income.
Adjusted income is
usually your net salary, other income like dividends, interest,
property income plus your salary sacrifice pension AND your employers'
contributions from your employment. You have the full allowance if your
threshold income is below £260,000.
If
your income exceeds these thresholds, the annual allowance may be
tapered by £1 for every £2 over. From 6 April 2023 there is a floor of
£10,000. Any excess contributions not covered by
brought-forward allowances will be taxed at your marginal tax rate in
your self-assessment tax return.
Brought forward allowances
If
you have had a pension scheme open in the three previous tax years and
have not used up all your allowances for those years, you may be able to
use up these and avoid paying the tax charge.
We
can assist on a chargeable basis with the calculations on your brought
forward allowances and any tapering, please contact your account manager
for details.