Carry forward is an excellent tool to enhance pension wealth before retirement, says Damien Bowler, Pensions Technical Manager, Curtis Banks.
Contributing to a pension offers numerous advantages for clients, both personally and for their employer or company. It serves as a tax-efficient means to prepare for life after work. Carry forward, in particular, presents an opportunity to enhance savings during periods of increased financial income or to make up for lost time due to reduced financial opportunities. It serves as a second chance to contribute towards the aspirational lifestyle people desire in retirement.
Pension carry forward is not a new concept and has been available since the 2011/12 tax year, coinciding with the first reduction in the annual allowance. This feature allows investors to utilise any unused annual allowance from the previous three years.
Given the pension shortcomings in our country, it’s worth considering whether carry forward is being fully utilised. While some may argue that it primarily benefits the ultra wealthy, I disagree. People experience positive changes in their income throughout their working lives, such as new jobs, promotions, bonuses, inheritance or new business ventures, to name a few. These feel like opportunities to take advantage of carry forward.
Let’s examine the current format and what a client can expect. In the current tax year (2023/24), a client can contribute up to £60,000. If an individual has held a pension but hasn’t made contributions in the previous three years, they can contribute up to the annual allowance limit for each of those years. Simplifying matters, if we assume each of the three previous years had an unused annual allowance of £40,000, this would result in a maximum carry forward of £120,000 that can be utilised.
To receive tax relief on carry forward contributions, the client would need income to support the full amount being utilised, including contributions made in the current tax year. In this scenario, the income required would be £180,000. If clients don’t intend to maximise the carry forward due to insufficient income or a desire for smaller contributions, it’s worth noting that the unused allowance won’t necessarily be lost unless it remains unused for three years. For example, if a client intends to contribute only up to the annual allowance limit for the current year, they would lose the opportunity to carry forward any unused annual allowance from the 2020/21 tax year once the 2023/24 tax year comes to an end.
After making the maximum contribution based on the limits in the current tax year, you then look back to the earliest year and work forward, considering unused annual allowances in each of those years. Referring to the scenario above, if someone wishes to contribute £120,000, £60,000 would be attributed to the 2023/24 tax year. Next, we would look at the 2020/21 tax year, where no contribution was made, and attribute £40,000 to that year. The remaining £20,000 would be attributed to the 2021/22 tax year. The remaining annual allowances for the 2021/22 and 2022/23 years will still be available if a client wishes to use further carry forward next year.
There are excellent opportunities for business owners to reduce corporation tax by utilising carry forward. Therefore, it’s important not to limit considerations to personal contributions only when utilising carry forward.
For clients who run successful businesses and have control over their remuneration, it’s an ideal opportunity to take advantage of carry forward. However, they should be mindful of the complex interactions between employer, employee contributions and the tapered annual allowance. By doing so, they can potentially reduce their taxable income, lowering their personal tax bill, and benefit from business tax relief.
Employer contributions are a deductible business expense and can, therefore, deduct the contributions from their taxable profits. As the taxable profits are reduced, the business will experience a lower tax liability since corporation tax is typically calculated on profits generated. Furthermore, the business will not need to pay National Insurance on the amount of the contribution, whereas it would have been the case if it had been paid as a salary, resulting in additional savings.
Pay rises and bonuses are a perfect opportunity to increase pension contributions, whether on a regular or one-off basis. This money is something clients haven’t been accustomed to receiving, making it less noticeable when contributed to the pension. If a pay rise or bonus is received, it presents an opportunity to utilise carry forward and maximise contributions. Not only will their annual income increase, allowing for the utilisation of carry forward, but depending on their tax band, they can claim tax relief. Higher rate taxpayers can benefit from the pension provider reclaiming 20% tax on their pension pot, and clients can then claim an additional 20% outside of the pension, making the tax position highly appealing.
In addition to considering income limits for personal contributions and the tapered annual allowance if applicable, it’s crucial to be aware that triggering the money purchase annual allowance (MPAA) will prevent the utilisation of carry forward to increase contribution limits. The MPAA is a reduction of the annual allowance, which will be triggered when someone draws benefits from their pension under flexi-access drawdown, via an uncrystallised funds pension lump sum (UFPLS), or if they were in Flexible drawdown before the 6th of April 2015. Once the MPAA has been triggered, the maximum annual allowance will be £10,000.
Carry forward is an excellent tool to enhance pension wealth before retirement. Some years may be financially challenging, but utilising the good years to catch up on missed pension contributions can minimise the impact. This could be the difference between a good retirement and a great one. Carry forward should be considered whenever possible and remember, if a client doesn’t use it they will eventually lose it.
