The new year is a time where people take stock of their finances and part of that is quite often to redirect a recent bonus into their pension.
Pensions are an amazing way to tax-efficiently save for retirement, and the more you contribute in the early years the more comfortable you will be in later life.
However, it is a little-known fact that there are limits on how much you can put into a pension tax efficiently. In some circumstances, you could inadvertently cause yourself a large tax bill, rather than benefitting from the valuable tax relief you intended.
This is a complex area, however, in very simple terms most individuals can contribute a maximum of £40,000 per annum. Any contributions above this level would not benefit from income tax relief and would attract a punitive tax charge, which is quite often payable to HMRC directly from your cashflow, rather than being settled via your pension fund.
Higher earners are most affected as the more you earn, the more the standard annual allowance is tapered down, in some cases to only £10,000 per annum. This is a significant decrease and quite often catches people out. Especially as we tend to contribute more to our pensions once our earnings increase.
Some people may benefit from carrying forward unused allowances from previous years, however, once these are used you are limited to a contribution level specific to your total earnings. The amount you can contribute will, therefore, vary from individual to individual, and will be specific to yourself depending on how much you earn. It is important to note at this stage that your total earnings, include PAYE income, self-employed income, dividends, rental income, P11d benefits…the list goes on. Importantly it does include bonuses and at this time of year, a lot of people elect to have these bonuses sacrificed into their employer’s pension scheme. This is a great piece of planning for many people and has historically been the best advice… but not for higher earners. Individuals earning over £110,000 need to be mindful of the imposed limits so as not to inadvertently cause a very costly tax issue.
The calculation is complex (it must be carried out in the year in question, not retrospectively) and it must be performed each as year as your total earnings vary.
You would, therefore, be wise to instruct a financial planner to do this for you. We could save you from a vast tax bill and help you put more money overall into your pension, for a retirement you can be excited about.