Dave Downie, Technical Manager, abrdn, has put together a checklist of 10 pointers to help paraplanners when looking to best advise clients on their pension contributions ahead of the April 5 tax year end.
The impending introduction of IHT on death benefits hasn’t diminished the value of pensions when it comes to retirement or wealth transfer. With tax relief available at a client’s highest marginal rate, they’re still the best place to save for most people.
Tax year end has always presented an opportunity to focus on pension funding opportunities with clients and make the most of any available allowances and tax breaks.
Here’s a checklist of points that may be worth considering as tax-year-end plans are reviewed.
1. Can clients use annual allowance to offset fiscal drag?
Paraplanners will be well aware that since 2023/24 there has been additional headroom in the annual allowance, which now sits at £60,000 a year up from its previous level of £40,000. Meanwhile, the personal allowance and basic rate bands have been frozen since 2021 and the additional rate tax threshold remains at £125,140.
With the freeze expected to last until 2028, more clients will be dragged into higher bands as earnings rise. However, clients who have crossed into the higher or additional rate thresholds might be able to use the extra £20,000 scope in their annual allowance to reduce the impact of higher taxes.
A pension contribution will extend both the basic rate and higher rate bands by the gross amount paid. Extending the bands may also provide an opportunity to reduce tax on bond gains taken in the year.
2. Is there carry forward available?
The opportunity is even greater if a client has had a recent break from any pension funding.
Maximising this year’s annual allowance, plus any unused allowance carried forward from the past three years, allows a maximum pension contribution of £200,000.
Of course, clients must have enough ‘relevant UK earnings’ in the current year to get full tax relief on individual contributions and most providers will not allow contributions in excess of earnings. Don’t forget that in addition to salary clients may also benefits in kind or a year end bonus which may boost their relevant UK earnings.
3. Can you boost a bonus using sacrifice?
The tax year end often coincides with end of year appraisals, and the potential for a bonus.
Instead of taking the bonus as cash, it might be in clients’ best interests for them to ‘sacrifice’ this in exchange for an extra employer contribution to their pension.
The client gets tax relief on the pension contribution and, as the employee’s remuneration is reduced, they and their employer will pay less National Insurance (NI). The employer could decide to pay some or all of this NI saving into the employee’s pension too – overall, it won’t cost them any more than paying the bonus.
The NI savings for basic rate taxpayers are even greater as they pay NI at 12% on income over £12,570. So, they effectively get 32% tax relief on pension contributions paid by sacrifice. It should be noted that employer NI will increase to 15% from April and so the benefits of sacrifice could be even greater next tax year where an employer agrees to such arrangements.
An important watch-out: bonuses in this tax year must be sacrificed before April to get the benefits outlined above. Failure to do this could mean that individuals lose one year’s annual allowance under carry forward, there may be no reinstatement of the personal allowance or child benefit, and a year’s tax-free growth may also be lost.
4. Can you avoid the tapered annual allowance?
The annual allowance is tapered down by £1 for every £2 of ‘adjusted income’ over £260,000 until it reaches £10,000.
But the full £60,000 allowance can be reinstated if the client can make a personal contribution large enough so that their ‘threshold income’ drops to £200,000 or less.
It is important to remember that tapering of the annual allowance for high earners is a dual test against both adjusted and threshold incomes. Each of these tests has a different definition of what counts as income for tapering purposes.
The starting point for both adjusted and threshold income is taxable income from all sources – not just employment income. Adjusted income also includes the value of any employer pension contributions.
Tapered income on the other hand ignores employer contributions unless they are part of a fresh salary sacrifice arrangement started after July 2015. But more importantly threshold income includes a deduction for any pension contributions paid personally by the individual.
This means a personal contribution which brings threshold income below £200,000 will ensure the full £60,000 annual allowance remains available.
5. Can pension funding help retain the personal allowance?
Similarly, personal contributions can help reclaim the personal allowance as they’re seen as a deduction from earnings.
The personal allowance is reduced by £1 for every £2 of earnings (specifically ‘adjusted net income’ or ANI) in excess of £100,000. It is lost in full for those with ANI in excess of £125,140 so any contributions that reduce ANI between £125,140 and £100,000 have an effective rate of tax relief of 60%.
6. Or can it help retain child benefit?
The entitlement to a child benefit – which is assessed on the highest earner of a household – is reduced by 1% for every £200 of ANI in excess of £60,000. It’s lost in full for those earning £80,000 or more.
Although these thresholds have increased from 2023/24, higher-earning households may still be at risk of losing it, potentially forfeiting £2,212.60 per year for a typical family with two children.
Making a pension contribution to reduce the ANI to the £60,000 threshold could offer an opportunity to claim this tax-free benefit, further improving the effective rate of tax relief on the contribution.
7. Does the removal of the LTA open up new opportunities?
Some clients may have slowed or stopped pension funding in recent years because of the lifetime allowance (LTA). The official ‘scrapping’ of the LTA this year may present them with new opportunities.
Clients may be in the position where their existing benefits exceed the ‘lump sum allowance’ (LSA), meaning they are not entitled to further tax-free cash. Those in this situation might not see a benefit to continuing to fund their pension.
The important thing is that pensions can still be a valuable place for these individuals to save, if their situation is tax neutral – i.e. the tax relief received on contributions mirrors the amount of tax payable when the benefits are taken. Only where a client’s tax position in retirement is likely to be higher than the relief on the contributions will they be worse off, for example if they withdrew all the benefits in one go.
And even though most pensions will form part of an estate from 2027, savers will still enjoy investment returns free of income tax and CGT.
This is tax-free growth that will be particularly attractive given the recent CGT allowance squeeze and the October 2024 increases in CGT rates – a good example of the value of continuing to fund pension pots.
8. Can clients with fixed or enhanced protection resume pension funding?
If individuals had enhanced or fixed protection, they had to stop paying into their pensions years ago as a condition of maintaining a higher LTA.
With the LTA abolished, the protection now provides a higher ‘lump sum allowance’ and ‘lump sum and death benefit allowance’.
Provided the protection was in place as of 15 March 2023 and hadn’t been lost or revoked before 6 April 2023, these individuals have been able to recommence pension funding since 6 April 2023 without invalidating their protection.
If nothing was paid last tax year, then a possible contribution of up to £200,000 could be made this year to boost savings by using carry forward before the new tax year.
However, bear in mind that personal contributions would need the ‘relevant UK earnings’ to justify them.
9. Does your client benefit from the rise in corporation tax?
Often, business owners will take a significant amount of their annual profit as a dividend.
It may be more economically advantageous for them in the round to use some of their profits to make an employer pension contribution instead.
Dividends are paid from profits after corporation tax. In contrast, a pension contribution will benefit from full corporation tax relief – up to 25% for those with profits over £250,000 paying the main rate of corporation tax.
10. Can clients plan as a couple?
Many clients won’t know that they can top-up pensions for their partners up to their partner’s earnings, with tax relief being given at the partner’s marginal rates of tax. They should consider maximising tax relief at higher rates for both, before paying contributions that will only secure basic rate relief.
Of course, the opportunity to fund someone else’s pension doesn’t stop at spouses and partners – children and grandchildren could also be beneficiaries. Regular gifting in this way from surplus income could be very IHT effective as the gifts may be immediately outside the estate for IHT if the conditions for the exemption are met.
Next steps
Pensions remain the most tax efficient way to save for retirement for most people. The ability to take 25% tax-free cash, coupled with the availability of tax relief during working life, outweighs the income tax paid in retirement and the impending introduction of IHT on death benefits.
Effective tax planning is a year-round job. But it’s only at the end of the tax year that you have all the information needed to use the allowances and reliefs in a tax efficient way.
Considering these factors can help ensure clients are taking advantage of all possible opportunities during this important period.
