Pension Contributions & Lifetime Allowance

FREQUENTLY ASKED BUSINESS QUESTION

My employer has indicated that I am due a significant bonus before the end of 2021/22 tax year.  I am considering taking pension contributions instead of a bonus but am unsure of the contribution rules and I have been told that I may have a lifetime limit issue?

TAX TIP

There are considerable tax and national insurance savings for both you and your employer if you opt to take a pension contribution instead of a bonus payment. The amount that a UK tax payer can contribute to their pension annually is capped at £40k.  If they have an existing pension scheme and have not made maximum contributions in the three previous years, they can also carry forward any unused contributions and make a very significant contribution in a single tax year.

Pension Contributions | The Facts

There are several complications, however, currently in the area of pensions.  The first of these is that pension contribution levels are restricted for very high earners.  Thankfully, the income level at which contribution levels start to be tapered has increased in recent years from £150k to the current level of £240k.  Once your adjusted income exceeds £240k, the annual £40k allowance is reduced by £1 for every £2 that income exceeds this level to a minimum of £4k.

On the assumption that you do not have a contribution limit issue and wish your employer to maximise your contributions using your unused relief, the next problem that you face is the actual size of your pension pot known as the “lifetime allowance”.

Pension Contributions | Lifetime Allowance

The lifetime allowance is the maximum amount that you can hold in your pension pot before incurring a tax charge and it is currently fixed at £1,073,100.  If you save more than this amount, large tax bills will be triggered when you withdraw money from your pension. Lump sum withdrawals incur a 55% penalty.

Historically, pension pots were unlimited however, successive governments have tinkered with this allowance bringing it down to its current level which started at £1m but was increased annually by inflation.  The Chancellor however has frozen the limit for five years until 2026 to try and assist in rebuilding public finances and this is going to affect tens of thousands of pension savers who will incur high tax charges given that inflation is currently 5.5% and set to go up to 7.25% by the summer.

Current predictions estimate that had this allowance not been frozen, in five years’ time it would have risen to £1.37m.  Therefore, its freezing affect on a saver is equivalent to a tax charge of over £150k.  If you expect to have a lifetime allowance issue, there are some measures that you can take now to protect your position.

Lifetime Allowance Protection

If your pension savings exceeded £1m at April 2016, you can apply for one of two protections:

1. The first is “Individual Protection 2016” which maintains your lifetime allowance at the lower of either £1.25m or the actual value of your pension pot on 5 April 2016 and you can continue to contribute to your pension, but you will have to pay tax on any withdrawals beyond the protected amount.
2. The other protection is called “Fixed Protection 2016” which fixes the allowance at £1.2m however, prohibits you from paying anything into your pension without incurring a tax charge.  The latter protection, therefore, is typically chosen by people who had large pension pots as of 5 April 2016 and to expect them to rise in the future without having to make further contributions.

Here to Help

The team at FPM are here to help with all your Tax queries, simply contact our Tax Team.

If you require guidance on pension contributions and lifetime allowances, we would advise that you contact your independent financial advisor without delay to determine firstly your ability to access any unused relief that you may have available and secondly, to assess your lifetime allowance position and whether or not you can and/or should apply for one of the available protections.