A Quick Guide To Pensions Tax Reliefs

At McDade Roberts we pride ourselves on helping businesses from start up businesses, all the way through to retirement planning. A key topic we get asked about is pensions and with the help of our sister company M.R. Financial Services we can help our clients with all their financial needs. Read below for a quick guide to pensions and tax relief.

Types Of Pension Schemes

There are two broad types of pension schemes from which an individual may eventually be in receipt of a pension:

  • Workplace pension schemes
  • Personal Pension schemes.

A Workplace pension scheme may either be a defined benefit scheme or a money purchase scheme.

A defined benefit scheme pays a retirement income related to the amount of your earnings, while a money purchase scheme instead reflects the amount invested and the underlying investment fund performance.

All employers will soon need to provide a workplace pension scheme due to auto-enrolment legislation and these are likely to be money purchase schemes.

A Personal Pension scheme is a privately funded pension plan but can also be funded by an employer. These are also money purchase schemes. Self-employed individuals can have a Personal Pension.

We set out below the tax reliefs available to members of a money purchase Workplace scheme or a Personal Pension scheme.It is important that professional advice is sought on pension issues relevant to your personal circumstances.

What Are The Tax Breaks And Controls On The Tax Breaks?

To benefit from tax privileges all pension schemes must be registered with HMRC. For a Personal Pension scheme, registration will be organised by the pension provider.

A money purchase scheme allows the member to obtain tax relief on contributions into the scheme and tax-free growth of the fund. If an employer contributes into the scheme on behalf of an employee, there is, generally no tax charge on the member and the employer will obtain a deduction from their taxable profits.

Key Features Of Money Purchase Pensions

  • Contributions are invested for long-term growth up to the selected retirement age.
  • At retirement which may be any time from the age of 55 the accumulated fund is generally turned into retirement benefits - an income and a tax-free lump sum.
  • Personal contributions are payable net of basic rate tax relief, leaving the provider to claim the tax back from HMRC.
  • Higher and additional rate relief is given as a reduction in the taxpayer's tax bill. This is normally dealt with by claiming tax relief through the self assessment system.
  • Employer contributions are payable gross direct to the pension provider.

Persons Eligible

All UK residents may have a money purchase pension. This includes non-taxpayers such as children and non-earning adults. However, they will only be entitled to tax relief on gross contributions of up to £3,600 per annum.

Relief For Individuals' Contributions

An individual is entitled to make contributions and receive tax relief on the higher of £3,600 or 100% of earnings in any given tax year. However tax relief will generally be restricted for contributions in excess of the annual allowance.

Methods Of Giving Tax Relief

Tax relief on contributions is given at the individual's marginal rate of tax.

An individual may obtain tax relief on contributions made to a money purchase scheme in one of two ways:

  • a net of basic rate tax contribution is paid by the member with higher rate relief claimed through the self assessment system
  • a net of basic rate tax contribution is paid by an employer to the scheme. The contribution is deducted from net pay of the employee. Higher rate relief is claimed through the self assessment system.

In both cases the basic rate is claimed back from HMRC by the pension provider.

A more effective route for an employee may be to enter a salary sacrifice arrangement with an employer. The employer will make a gross contribution to the pension provider and the employee's gross salary is reduced. This will give the employer full income tax relief (by reducing PAYE) but also reducing National Insurance Contributions.

There are special rules if contributions are made to a retirement annuity contract. (These are old schemes started before the introduction of personal pensions.)

The Annual Allowance

The annual allowance is £40,000. Any contributions in excess of the £40,000 annual allowance are potentially charged to tax on the individual as their top slice of income. Contributions include contributions made by an employer.

Carry Forward Of Unused Annual Allowance

To allow for individuals who may have a significant amount of pension savings in a tax year but smaller amounts in other tax years, a carry forward of unused annual allowance is available.

The annual allowance for the current tax year is used before any unused allowance brought forward. The earliest year unused allowance is then used before a later year. Unused annual allowance carried forward is the amount by which the annual allowance for that tax year exceeded the total pension savings for that tax year.

The Lifetime Limit

The lifetime limit sets the maximum figure for tax-relieved savings in the fund at £1,073,100 for 2021/22 and 2020/21.

Accessing Your Pension - Freedom

Individuals have flexibility to choose how to access their pension funds from the age of 55. The options include:

  • a tax free lump sum of 25% of fund value
  • purchase of an annuity with the remaining fund, or
  • income drawdown (see below for options available regarding flexi access accounts and lump sum payments).

An annuity is taxable income in the year of receipt. Similarly any monies received from the income drawdown fund are taxable income in the year of receipt.

Flexi Access Accounts And Lump Sums

Where a lump sum and annuity are not taken access to the fund can be achieved in one of two ways:

  • allocation of a pension fund (or part of a pension fund) into a 'flexi-access drawdown account' from which any amount can be taken over whatever period the person decides
  • taking a single or series of lump sums from a pension fund (known as an 'uncrystallised funds pension lump sum').

When an allocation of funds into a flexi-access account is made the member typically will take the opportunity of taking a tax free lump sum from the fund. The person will then decide how much or how little to take from the flexi-access account. Any amounts that are taken will count as taxable income in the year of receipt. Access to some or all of a pension fund without first allocating to a flexi-access account can be achieved by taking an uncrystallised funds pension lump sum.

The tax effect will be:

  • 25% is tax free
  • the remainder is taxable as income.

Money Purchase Annual Allowance (MPAA)

The government is alive to the possibility of people taking advantage of the flexibilities by 'recycling' their earned income into pensions and then immediately taking out amounts from their pension funds. Without further controls being put into place an individual would obtain tax relief on the pension contributions but only be taxed on 75% of the funds immediately withdrawn.

The MPAA sets the maximum amount of tax efficient contributions in certain scenarios. The allowance is currently set at £4,000 per annum. 

There is no carry forward of any of the annual allowance to a later year if it is not used in the year.

The main scenarios in which the reduced annual allowance is triggered are if:

  • any income is taken from a flexi-access drawdown account, or
  • an uncrystallised funds pension lump sum is received.

However just taking a tax-free lump sum when funds are transferred into a flexi-access account will not trigger the MPAA rule.

How We Can Help

Still got questions? We can help. The above provides general information on the making of pension provision. Please contact us for more detailed advice if you are interested in wealth management and future retirement planning including pensions.