If you top up your pension pot then some of the money you save may be eligible for tax relief, provided you’re within the pension contribution annual allowance. However, the tax relief rules are complex! Matt Merchant, an independent financial adviser at Scrutton Bland explains what this means for high earners.
Since the beginning of the 2016/17 tax year, individuals earning over £150,000 a year may have had their annual allowance for pension contributions reduced from £40,000 to as low as £10,000 per annum. As we enter the 2019/20 tax year we are now in a position where someone’s maximum pension contribution, if they have not contributed over the past three tax years, could be as low as £40,000 to cover four tax years’ worth of allowances rather than £40,000 each year.
If you (or your employer) makes pension contributions in excess of your annual allowance and available carry forward, you will face an annual allowance charge on the excess. This charge is applied in a similar way to Income Tax, so for high earners the excess pension contribution will likely suffer a tax charge of 45%.
Combine these restrictions on pension contributions with the Lifetime Allowance for pensions savings (£1,055,000 in 2019/20) and there comes a point where making pension contributions becomes less suitable for high earners. Not only could the contributions face an annual allowance charge on the way in, effectively removing the tax relief benefit, but when it comes to using your pension for its main purpose: retirement funding, there will be a Lifetime Allowance Charge if your total pension savings exceed the Lifetime Allowance as well.
So what else could high earning individuals do in place of pension contributions?
One of the main reasons to review your pension contributions is the Income Tax relief available and the reduction this can have on your Income Tax liabilities. There are specialist investments such as Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT) that can be used to claim Income Tax relief of up to 30% of the amounts invested. Both of these investment structures offer other tax benefits in addition to Income Tax relief but they are considered high risk investments and you should always seek independent financial advice before investing in these schemes.
Other alternatives to pension contributions can include more established investments such as Stocks and Shares ISAs, General Investment Accounts and Investment Bonds. These savings plans can be set-up in line with your individual attitude to risk and long-term objectives, but it is important that they are reviewed on an ongoing basis with your financial adviser to ensure they remain suitable.
All of these options have their benefits, and come with their own tax advantages, so it is likely that no one solution will be appropriate on its own and a combination of investments may well be more beneficial.
Scrutton Bland Financial Services Limited is authorised and regulated by the Financial Conduct Authority