The rules on what can be paid into a pension, by a higher earner, changed on 6 April 2020 to take into account the Chancellor’s budget on 11 March 2020 and increases to the two important income tests.
To recap, there was one test to see whether tapering is likely to apply, which broadly is that if an individual’s income is greater than £200,000 less any personal contributions (threshold income). In the 2020/21 tax year, they must do a second test to check whether their total income plus employer pension contributions is greater than £240,000 (adjusted income).
The question I’ve been asked on several occasions, is whether an individual who is not tapered, or only somewhat tapered, should seek to make a contribution now, to make use of their 2020/21 allowances, or whether they should wait.
There are several considerations, which I’ve not covered here, such as affordability, ability and need to access the pension, but I would like to focus on two key considerations that are relevant, and often overlooked. This is not meant to be an exhaustive list of the considerations.
Firstly, have all allowances in the 2018/19 tax year being used? If they have not, and an individual is able to carry forward this allowance, then they must fully make use of their 2021/22 pension allowance before they can bring forward this oldest year’s allowance. If they do not do this by 5 April 2021 (also Easter) then this allowance will be lost forever.
The next consideration is what that pension saver thinks about future tax changes. This has two aspects: firstly, there is always the risk of further reductions in either the amount of contribution permitted into a pension, or the amount of tax relief that the saver is granted. By deferring making a contribution today there is a risk that the rules change to their detriment before the next contribution is made.
Conversely, tax rates may rise. Currently most of these high earners, that had previously been tapered (often over £150,000 of earnings), should be able to receive at least 45% tax relief on their pension contribution, possibly more if they are able to elect for an employer’s “salary sacrifice” scheme or similar. If taxes rise, in this budget on one near future, without a commensurate change in pension rules, delaying a pension contribution until this time might result in increased tax relief.
A really important point, that is often overlooked goes back to the two definitions of income given above. Carrying forward this year’s contribution allowance, to a future year, can have an additional benefit if this allows a greater personal contribution that reduces the first definition of income (threshold income – the one where the personal contributions deducted) and this action might exempt somebody from the second test where they might ordinarily be tapered. Perversely, paying in less this year could permit more in future years.
As you can gather this is a complex area of advice, but it is an area I specialise in. As I have said above there are factors that I have not considered, for example, requirements to allow the carry forward to be available.
So if this is something that interests you as a topic please do not hesitate to get in contact using the links on this page.