Pension changes offer a golden opportunity for higher earners

Pension changes brought in at the Spring Budget now mean some higher earners can contribute up to £30,000 a year more tax efficiently into their pension.

Most people are aware that if you are working in the UK, you are likely to be building up a pension pot for later life. However, what isn’t always clear is that there are limits to the amount that you can contribute to a pension, tax efficiently each year. For most people who are working, the most that you can contribute is £40,000 per year, known as the annual allowance.

The annual allowance hasn’t always been the same. In fact, in 2010 it was £255,000, and was reduced to £50,000 for the 2011/12 tax year. In April 2014, the allowance was again reduced to £40,000, and it has remained at this level ever since.

However, once you are earning over a certain income, the annual allowance starts to reduce. In pensions jargon, that is what’s known as the tapered annual allowance.

The tapered annual allowance was introduced in April 2016, and subsequently reduced the amount that high earners could contribute tax efficiently to a pension. One of the groups that were most affected were NHS doctors, who as a result, started turning down additional work so that they wouldn’t be caught by the tapered annual allowance.
In March 2020, the government announced changes to the tapered allowance and to illustrate the changes we’ve considered an example.

In June 2019, Sarah was earning a salary of £200,000. The limit, at that time, where the tapered annual allowance came into effect was £150,000 – otherwise known as adjusted income. Adjusted income is defined as her total taxable income, plus any pension contributions made by her employer. What the tapered annual allowance meant for Sarah was that for every £2 of her adjusted income above £150,000, the annual amount that she could contribute tax efficiently to a pension, was reduced by £1. The result being that Sarah’s annual allowance of £40,000, was reduced by £25,000, meaning that she could only contribute £15,000 per year to her pension, without suffering a tax charge on the excess.

However, as a result of changes that took place in the Spring Budget, the adjusted income threshold has been increased to £240,000 from £150,000. What that means is that if Sarah is earning the same amount of income in June 2020, she will retain her full annual pension allowance of £40,000.

Instead of the tapered annual allowance taking effect at £150,000, it will now start to reduce for income above £240,000. That means that if she is earning £300,000, her annual allowance will only be £10,000.

The changes that have come into effect also state that if an individual’s adjusted income is £312,000 or above, the annual amount that they can contribute to a pension is limited to £4,000.

What do the changes mean?

Overall, these changes are very positive news to most high earners. The changes to the adjusted income threshold now mean that if your total taxable income plus employer pension contributions are between £150,000 and £240,000, you will be able to contribute up to £40,000 per annum to your pension, which means that you could be able to contribute up to £30,000 more into your pension than in the previous tax year.

The changes are also positive if you have adjusted income between £240,000 and £300,000. Again, under the previous restrictions if you were earning £210,000 or more you would only have been able to tax efficiently contribute £10,000 to your pension each year. Whilst the amount you can contribute to pension will be reduced by £1 for every £2 above the £240,000 threshold, you are likely to be able to contribute more to your pension than you used to.

Could now be a great time to act?

The latest changes to the amount you can contribute to a pension are a great incentive to building up a pension pot for your unknown future. Add to that are the whole range of benefits to contributing to a pension, such as tax relief on employee and employer (business owners) contributions, tax-free investment growth, and that pensions are normally outside of your estate for inheritance tax purposes.

What is more, investors have been more encouraged by the recent improvements in the global economy, with financial markets having improved since the significant falls that we experienced in March and April. The change to the amount that you can contribute to a pension, coupled with the improvement in financial markets, could represent a great time to top-up your pension contributions.

Should you act upon these changes?

Ultimately, choosing to contribute more towards your pension depends upon your personal circumstances. You may be in a position where contributing more to your pension is the last of your worries. After all, there remains a lot of uncertainty in the world.

However, if you’re a higher earner with some cash that you have been able to save during the current crisis, or you’re looking to grow your wealth for the long-term, changes to the amount that you can contribute to your pension could present the perfect financial planning opportunity.

If you would like to speak to one of our pensions experts about your own personal circumstances please get in touch.

We’re currently offering all of those with £100,000 or more in pensions, savings or investments the opportunity for a free retirement planning review worth up to £500. Click here to find out more or book your appointment today.

This article represents our understanding of HM Revenue & Customs practice as at 01/07/2020.

Past performance is no guarantee of future returns. The value of investments and the income from them can fall as well as rise, you may not get back what you originally invested.

The Financial Conduct Authority (FCA) do not regulate estate planning, tax or trust advice.