Making the most of your pension allowances

The current tax year is coming to an end (5 April 2022, to be specific), and there’s no better time to start running through your tax year end checklist. There is still time to take advantage of the tax benefits that a pension offers, regardless of whether you are still contributing towards it or already drawing an income.

Saving for your future

Whilst there is no official limit on how much you can invest in a personal pension each year, there is a limit on the amount that will qualify for tax relief. The annual allowance, currently £40,000, is the maximum amount of pension savings you can make each year that will benefit from tax relief. This also includes pension contributions made by your employer or a third-party. It is important to note that tax relief is restricted to the higher of £3,600 or 100% of relevant UK earnings.

Higher-rate and additional-rate income taxpayers can claim additional tax relief of 20% and 25% respectively (different rules may apply if you are a Scottish taxpayer). As such, if you have a remaining allowance, you could look to maximise your contributions ahead of the tax year end and claim additional tax relief.

Some employers may also allow you to make pension contributions via salary sacrifice, which allows you to benefit from both tax relief and a National Insurance saving. If you are lucky enough to receive an annual bonus, this could also be ‘sacrificed’ to your pension scheme to benefit from the tax advantages.

Pension tax loopholes

There is also a pension carry forward rule, which allows you to make pension contributions over the annual allowance and still receive tax relief. In the current tax year, alongside your £40,000 contribution, you may be able to carry forward any unused allowances from the previous three years.

However, a key aspect of the pension carry forward rule is that you can’t receive tax relief on contributions in excess of your earnings in any tax year. For example, if you earn £60,000 in a tax year, you can only contribute up to £60,000 to your pension before the end of the tax year and receive the relevant tax-relief.

Depending on previous pension contributions, you may be able to make a larger one-off contribution. 7IM can work with you, your employer or accountant to calculate the maximum contribution available ahead of the end of the tax year.

Drawing your pension income

The pension freedom rules, which came into effect in April 2015, changed the way people can take money out of their pensions, with new options available to anyone over the age of 55. You are now no longer required to purchase an annuity (guaranteed income for life) and instead can withdraw funds from a pension, as and when it is required.

Pension drawdown allows you to access your pension pot to provide you with a regular income. The income you get varies on your fund’s investment performance and, unlike an annuity, it isn’t guaranteed for life. However, it may be suitable for those who would like more control over how their money is invested. It may also benefit you if you want the flexibility of taking out different amounts during the year and want to manage your tax liability. Most pensions offer a lump sum of up to 25% of the value to be taken free of income tax, which can be withdrawn in phases or taken all at once.

There are of course lots of considerations before entering drawdown; if you want a guaranteed income for life, are concerned about running out of money, or don’t want to expose your pension pot to investment risk, income drawdown may not be for you.

It’s important to note that tax rules are subject to change and taxation will differ depending on individual circumstances, so it’s always best to consult a financial adviser before making any decisions. Please remember, this article does not constitute advice or a recommendation and is purely intended for educational purposes.

Please be aware that the value of investments may go up and down and you may receive back less than you originally invested.