Planning for Retirement? Know Your Limits

“We are all no doubt hoping for a comfortable retirement. The Government is naturally in favour of us building our own pension provision, reducing reliance on state support. However, much like a good night out, it is best to know your limits” says chartered financial planner, Andrew Haley

‘Pension simplification’ took effect on 6 April 2006 and brought in a new tax regime for all pension schemes. There is plenty of debate as to how successful the Government were in ‘simplifying’ pension legislation, but regardless, we have all been subject to these rules since.

Limits to building your pension

The main incentive designed to encourage us to pay into our pensions is the tax relief. How the tax relief applies to you personally will depend upon several factors, but generally speaking if we personally contribute £80 to a pension, this will be topped up with £20 by HMRC. You may then be eligible for further tax-relief if you are a higher or additional rate taxpayer. Technically, there is no limit to these contributions, but tax relief on personal contributions is restricted to the higher of £3,600 or 100% of ‘relevant UK earnings’.

Employers can also contribute to an employee’s pension. Employer contributions can be claimed as a business expense and although there are not the same tax relief limits as with personal contributions, there is a ‘wholly and exclusively’ limit to consider.

We also need to be aware of the annual allowance; the rules operate separately from the tax relief rules but it is important to consider both when building your pension.

The annual allowance began at £215,000 in 2006/07, reaching £255,000 at its highest in 2010/11, but has remained at £40,000 since the 6th April 2016. The type of pension scheme you are a member of will influence the ‘pension input amount’ for annual allowance purposes. There is also the potential to carry forward some of your previous unused allowance, potential tapering for high earners, and a lower ‘money purchase annual allowance’ for those who have flexibly accessed pension benefits.

Some employees, particularly those in active defined benefit schemes might have been caught off guard by annual allowance breaches. It is our responsibility as individuals to self-assess any annual allowance charge.

The overall ‘limit’

There is technically no limit to the overall amount you can receive – or ‘crystallise’ from a pension. There is however a significant tax allowance, known as the lifetime allowance (LTA), which once breached, results in tax charges.

Much like the annual allowance, the LTA has seen notable reductions from its high point. The LTA was introduced at £1.5 million in 2006, reached a high of £1.8 million in 2010, but now sits at £1,073,100. In addition to this, the (LTA) limit has been frozen and is not due to rise until April 2026.

What was once a tax paid by very few has now become far more common with 8,510 LTA charges reported in 2019/20 totalling £342 million (a 21% increase on 2018/2019)*

Again, there are plenty of technicalities to keep LTA planning interesting, with different ways of valuing defined contribution and defined benefit pensions, options as to how you receive benefits impacting the tax you pay, and sadly the limit can’t even be escaped on death.

There are ways to make planning for and dealing with these limits less painful.  Working with a financial planner can help bring much needed clarity. If this is something you would like to explore, Active Chartered Financial Planners are here to help

*Source: https://www.gov.uk/government/statistics/personal-and-stakeholder-pensions-statistics/commentary-for-personal-and-stakeholder-pension-statistics-september-2021

The information provided must not be considered as financial advice.

We always recommend that you seek financial advice before making any financial decisions

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