By Louise Misiewicz
Do you know how much tax relief is available for your pension contributions?
Could you be facing an income tax charge if your employer makes too much of a pension contribution?
As a leading tax and pensions expert, I have written many different articles on pension contributions, including the recent examples below:
My team of property tax experts are on hand to best advise our clients on how to maximise their pension contributions in the most tax-efficient way, and it’s also worth considering the impact of pension contributions within your overall property portfolio and wealth planning arrangements during 2017.
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With that in mind, I wanted to talk further about pension contributions, as many of my clients are unsure of their tax position around pension contributions and liabilities they need to consider in tax planning.
Depending on who makes the pension contributions is the entity that receives the tax relief.
So, if you (the employee) make pension contributions, then you receive the tax relief. If the employer makes the pension contributions, then the company will receive corporation tax relief.
That bit was the easy part.
Pension Contributions Annual Allowances
As we have shown in a previous article here, which demonstrated how tax relief was attributed to the pension contributions made. In summary, I will focus on the fact that we can all obtain tax relief on contributions based on a minimum of:
- £3,600 (for those not paying income tax); or
- the entirety of the member’s relevant UK earnings (up to the annual allowance of £40,000)
While those making pension contributions will benefit from tax relief on their contributions, this is limited to £40,000 per year. (see more here on pension contributions annual allowances).
You can go back at least two tax years and make pension contributions to utilise your annual allowance. Therefore you could, in effect, make £120,000 of pensions contributions in two years’ time.
If you make pension contributions and are not part of a ‘salary sacrifice scheme’, then you may only receive basic tax relief from the pension scheme.
As such, you will need to reclaim the additional tax if you are a higher rate or additional rate taxpayer on your self-assessment.
You’ll get a statement from your pension provider telling you how much tax you owe if you go above your lifetime allowance. Your pension provider will also deduct the tax before you start getting your pension.
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Employers making pension contributions
Employers may reduce their corporation tax liability by the amount of money that they have invested into the pension as it is deemed that employer contributions are an allowable cost.
Sections 307 and 308 of the Income Tax (Earnings and Pensions) Act 2003
The contributions an employer makes to a registered pension scheme on behalf of an employee are exempt from being taxed as earnings for the employee.
However, the employer’s contributions will count towards the member’s annual allowance limit, so the member may have to pay tax if the employer contributes too much.
Where the employer is a company with investment business, the employer contributions will be deductible as an expense of management (Chapter 2 of Part 16 of the Corporation Tax Act 2009).
Pitfalls of pension contributions
It is possible that an employer may have made £40,000 pension contributions on the behalf of the employee. However, without both the employee or employer knowing that the level of contributions has exceeded the annual allowances. In this case, we will assume that the employee is a high rate tax payer. The £10,000 excess will then have a £4,000 (40%) tax charge.
It can get much worse, without the right tax advice and wealth planning professional inputs. Let’s assume that an employee draws down some of his pension to get 25% tax relief and starts to take the pension benefits annually. This would reduce their pension contribution annual allowances from £40,000 to £10,000 based on the governments website known as Money Purchase Annual Allowance (MPAA).
If we now look back and see that the £40,000 pension contributions exceeds the £10,000 by £30,000. As such, the employee will then have to pay tax of £12,000 (£30,000 x 40%).
You need to be mindful of:
- What your annual allowances are for pension contributions
- Who make the contributions
- Who gets the tax relief
If you are a business owner, it provides additional benefits:
- Gets money out of the limited company in a tax-efficient way
- The above reduces the overall value of the business from an inheritance tax perspective
- You do not need to increase your salary costs to make the pension contributions, which would incur national insurance costs for both the employee and employer
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