Your pension is incredibly tax-efficient, but only if you make the most of the tax efficiencies it offers.
At Lloyd O’Sullivan, we can help you manage your retirement in the most tax-efficient way possible, from helping you understand tax relief on contributions to the thresholds and hidden charges that could affect the retirement options you choose.
Here are five potential pension tax traps you need to be aware of.
1. Understanding the pension Annual Allowance
Your pension Annual Allowance is the amount you can pay into your pensions each year, while still benefiting from tax relief.
For 2021/22, the allowance stands at £40,000 (or 100% of your pensionable earnings, if lower).
You can contribute up to £40,000 a year and still receive tax relief on your contributions. Relief is given automatically at the basic rate of 20%. If you are a higher- or additional-rate taxpayer a higher rate of relief is available (more on which later).
2. The pensions taper
In certain circumstances, the Annual Allowance that applies to you might be different from the usual £40,000. This might be the case if you are a high earner.
To decide if the tapered allowance applies to you, you’ll need to look at your “threshold” and “adjusted” income.
Put simply, your threshold income is your taxable income, including your salary (plus bonuses), pensions, rental income, and investment income. Your adjusted income, meanwhile, is largely the same, except that it also includes the employer pension contributions you receive.
If your threshold income exceeds £200,000 and your adjusted income is more than £240,000, your Annual Allowance will reduce by £1 for every £2 you are above the threshold income amount. The taper applies down to a minimum of just £4,000.
This severely limits the pension contributions you can make while still benefiting from tax relief.
3. The dangers of triggering the Money Purchase Annual Allowance (MPAA)
You might also find you have a lower Annual Allowance if you take pension benefits using certain flexible options. These were introduced back in 2015, as part of Pension Freedoms legislation.
You’ll trigger the MPAA if you take a lump-sum payment known as an “uncrystallised funds pension lump sum” (UFPLS). This option allows you to take all or part of your pension as a lump sum. You receive 25% tax-free, with the rest taxed at your marginal rate.
Allocating pension funds to flexi-access drawdown will also trigger the MPAA, but only from the point that you start to withdraw a taxable income.
The MPAA lowers your Annual Allowance to just £4,000. This means you’ll be severely limited in on the tax relief you can receive on future pension contributions. This is bad news if you intend to keep contributing to other plans you hold.
4. Make the most of pension tax relief
As previously mentioned, tax relief is added automatically to your pension contributions at the basic rate of 20%.
This means that a £100 contribution costs you just £80. As a higher-rate taxpayer (40%) you can claim an additional 20% of relief through your self-assessment tax return. Your £100 contribution costs you just £60. For an additional-rate taxpayer (45%), the cost of a £100 pension contribution is just £55.
Recent reports suggest that 8 out of 10 higher-rate taxpayers aren’t claiming this extra relief, missing out on a collective £810 million. Be sure that this isn’t you by making full use of your pensions tax efficiencies and claiming the additional relief due to you.
5. Be aware of the frozen Lifetime Allowance (LTA)
The Lifetime Allowance (LTA) was introduced in 2006 and dictates the amount you can withdraw from your pension without triggering an additional LTA charge.
The LTA charge applies when you exceed the allowance and is payable at 55% on excess funds you take as a lump sum and 25% where the excess is taken as income.
The LTA had been rising each year in line with inflation, but chancellor Rishi Sunak froze the allowance in his 2021 Spring Budget. It will now remain at its current level of £1,073,100 until at least 2026.
Pension growth over the next five years could see you become liable for a charge so be sure to speak to us if you are worried about the LTA.
Get in touch
If you’d like help managing your pensions – whether you’re approaching retirement and still contributing or struggling to manage your income effectively – please get in touch. Email firstname.lastname@example.org or call 020 8941 9779.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.