Pension contributions: act now to maximise tax efficiency

Personal pension contributions continue to benefit from income tax relief up to your highest marginal rate and employers can benefit from corporation tax relief. In addition, the underlying pension funds grow free of Corporation Tax on income and capital gains, 25% tax free cash (capped at £268,275 unless protection is in place) is still available, and most pension funds sit outside of the estate for inheritance tax (IHT) purposes. Following the announcement made in the Autumn 2024 Budget, pension funds will be subject to IHT on death from April 2027.

No-one knows how long the current rules on tax-free cash or income tax relief will continue, and so it makes sense to enjoy these opportunities while you can. As a reminder, the maximum amount you can personally contribute to a personal pension or stakeholder pension plan, on which you can receive tax relief, is 100% of your earnings or £3,600 gross, whichever is greater. Overall tax-efficient pension funding, employer and personal contributions combined, is capped at the annual allowance which, for the 2024-25 tax year, is £60,000.

Pensions tax efficiency for high earners has been cut by introducing a tapered annual allowance for those with adjusted incomes of over £260,000. For every £2 of adjusted income over £260,000, the annual allowance is reduced by £1, down to a minimum of £10,000 where an individual has adjusted income of £360,000 or more.

Where an individual is already in receipt of flexible pension income from a money purchase / defined contribution pension, the money purchase annual allowance (MPAA) applies, and the annual allowance for future money purchase pension funding is reduced to £10,000.

Annual Allowance summary

Key points

Subject to having been a member of a UK registered pension scheme for the previous 3 years and having sufficient UK relevant earnings in the tax year the contribution is made, high earners retain the ability to carry forward any unused annual allowances from the previous three tax years. This could enable larger contributions to be made, which will attract income tax relief of up to 45% (48% in Scotland). The MPAA cannot be increased using carry forward.

Planning opportunity: what is carry forward?

You are allowed to carry forward any unused annual allowances from the previous three tax years, starting with the earliest year, to make a pension contribution in excess of the annual allowance, as long as you were a member of a UK registered pension scheme in each year being carried forward from.

It is still possible to use this carry forward even if you are subject to a tapered annual allowance. The maximum available amounts of unused annual allowance remain at £40,000 for tax years, 2021-22 to 2023-24, meaning that it may be possible to make a maximum pension contribution of up to £200,000 in tax year 2024-25.

However, if adjusted income has exceeded £312,000 in 2021-22 to 2022-23 and exceeded £360,000 in 2023-24 the maximum tax-efficient pension contribution would be £28,000 (see table above). This is subject to the MPAA not having been triggered and the Threshold Income being breached.

The amount that can be carried forward from any tax year to which the taper is applied is the balance of the tapered annual allowance. If you do not use your annual allowance entitlement from 2021-22 by 5 April 2025, then this allowance will be lost.

What action can I take?

The calculations can appear complex. You must use up your annual allowance for the current tax year first. Any outstanding annual allowance can then be carried forward from 2021-22 onwards (the earliest of the three carry forward years available).

Please be mindful that you must have been in a pension arrangement in an earlier year to have unused annual allowance to carry forward, although you don't need to have contributed to that pension plan.

There remains an excellent opportunity for high earners to make use of the unused allowance from the tax year 2021-22 before it is lost (after 5 April 2025).

Will I be affected by the reduction in the annual allowance?

The definition of income for the £260,000 figure is ‘adjusted income’ which is total taxable income from all sources including earned income plus employer pension contributions. All pension contributions are included in annual allowance calculations (though the calculations of the amounts to be included differ between defined contribution and defined benefit arrangements).

If adjusted income is more than £260,000, the taper will only take effect if the ‘threshold income’ limit (currently £200,000) is also breached. This test is intended to help protect those with spikes in earnings or contributions. If an individual’s net income is less than the £200,000 threshold, then they will not normally be subject to the tapered annual allowance.

Care is needed here, with any new salary sacrifice arrangement (set-up on or after 9 July 2015), which may be included in the threshold income calculation. If in doubt, please speak to us for guidance. The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.

Also, it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

Next steps

The aspects of pensions are complicated, so seeking advice is essential.

To discuss this, or other pension issues in more detail, please contact us.