The Fizz! Blog

Are you getting all the tax relief you can on your workplace pension contributions?

Automatic Enrolment pension schemes have been with us for more than 10 years now. They’ve been a success. They represented a change from “you can contribute some of your salary to a pension if you want to, but you’ve got to set it up yourself” to “some of your PAYE earnings will automatically be contributed to a pension unless you take positive action to come out of it, and then keep taking that action every few years if you want to stay out of it”. It was thought that many people might come out, but plenty would stay in. In fact, the vast majority stayed in. The government tops up your own contribution AND your employer has to contribute too - generally, people have to be very short on income in order to be willing to sacrifice the free money.

There’s a complicating factor, which is that there are two mechanisms by which the schemes can operate (and all employers pick one and one only - you don’t see them giving employees a choice). There’s no difference in how the employer contributions work, but there is a difference in the tax relief on the employee’s own contributions:

• Relief at Source (RAS). In these schemes, for every £8 you contribute, HMRC add another £2. That means everyone gets 20% tax relief from the outset - £10 in their pot at the cost of £8. If your income is above £50,270, and you’re therefore paying tax at a rate above 20%, you can save more tax, but you have to do a bit of extra work to get it.
• Net Pay Arrangement (NPA). In these schemes, your contribution is knocked off your salary before the tax on your payslip is worked out. That means that the tax relief you get depends upon your income:

1. If your income for the year is going to be less than £12,570 anyway, you’ll get no tax relief at all! The tax on your payslips was going to be zero, it’s still zero.
2. If your income for the year is going to be between £12,570 and £50,270, then the reduction in your gross means that you save 20% tax on the contribution. Just the same as your friend in an RAS scheme.
3. If your income for the year is going to be over £50,270, then you’ll save tax via the tax deduction on your payslip at a higher rate - the exact rate depends on your income. The best case scenario is if your income would otherwise be between £100,000 and £125,140 - the reduction in your gross means that you save 60% tax on the contribution! You don’t need to do anything to get all the tax relief you’re due, it all happens on your payslip.

There’s one type of person who loses out permanently here. It’s NPA person #1. They get no tax relief at all! The lowest income people, if they’re in an NPA scheme, get the least government contribution to their pot. An employer who is likely to employ a bunch of people like this might lean towards an RAS scheme if they were kind.

A person who has income between £12,570 and £50,270 should be indifferent to which mechanism is in use. They save 20% either way.

A person who has income above £50,270 should be more or less indifferent between the mechanisms as they needn’t miss out anything - but if they’re in an RAS scheme they just have to put a little more effort in. If they have to do a tax return anyway, the work is minimal - keeping track of their contributions for a tax year and sticking the number in a box on the return. If they don’t have to do a tax return, it’s still not that much work. They don’t have to join the tax return system - they can just write to HMRC once a year to tell them about their contributions, or tell HMRC via their Personal Tax Account. HMRC will just get the employer to adjust their monthly PAYE deductions to get to the right overall result.

In reality, there are likely to be tens of thousands of people who should be doing this, but aren’t. If you’re a higher-rate taxpayer and you don’t know what kind of scheme you’re in, it’d be a good idea to find out! The most commonly used provider, NEST, is a RAS scheme - 20% relief at the time, but you’ve got to do the work yourself to get any further relief you’re due. The second most commonly used provider, The People’s Pension, offers employers a choice of either option at the setup stage, so it could be either! You’d be able to find out from your employer, or from your online account - or from an accountant or PAYE professional looking at your payslips! And if you’re actually in a salary sacrifice system - which is probably the third most common way of dealing with all this - then that’s effectively an NPA, so you’re getting all your relief up-front.

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Going on maternity leave? Think twice about opting out of your employer’s pension scheme

When someone's about to go on maternity leave, they'll quite often look at trying to temporarily cut all unnecessary overheads.  You might think that one sensible step would be to opt out of their employer's pension scheme for a while.  Cutting this particular overhead is probably a very bad idea though.

If your employer operates their Automatic Enrolment pension scheme on the most common basis, you’ll be making a contribution each month, and so will they.  Those contributions vary according to your income, and get capped if you’re earning more than £50,000 per annum.

If you go on maternity, your income drops, and so do your contributions.  In fact, after the first six weeks of leave, from which point your salary will probably just consist of basic Statutory Maternity Pay, they’re likely to drop to zero.

But, crucially, your employer’s contributions do NOT reduce at all.  They’re obliged to carry on paying into your pension pot at the level mandated by your normal salary!  Other non-salary benefits work on the same basis, too; they can’t take away your company car or withdraw your medical insurance, for example.

So, by opting out at the start of maternity, an employee could lose nine months of employer pension contributions, whilst saving herself virtually nothing.  A very easy trap to fall into!

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Can I make pension contributions for family members through my limited company?

The rules on how much money can go into someone’s personal pension in a tax year aren’t intrinsically complicated - there are just lots of them. Broadly:

• Almost anyone (even an infant) can have up to £3,600 go into a pension scheme or schemes in a tax year.
• The cap each tax year (the Annual Allowance) on what can go in is £40,000.
• However, unused Annual Allowance from the prior three years can be used too (if you had a pension pot of some sort in place at the time).
• Personal contributions in any year are capped at earned income.
• Employer contributions aren’t capped in that way (so a director with a small salary isn’t limited to contributions equivalent to that salary - their company can contribute more).
• Annual Allowance may be reduced for those with income over £200,000.
• The Lifetime Allowance may prohibit or penalise contributions for those with very big pension pots.

All simple individually, but the synthesis of them can be complex!

There’s another consideration involved where contributions are being made via one’s own limited company. For the company to get tax relief on the contributions, the same standard must be met as for any other overhead - is the cost incurred wholly and exclusively for the purpose of the company’s trade? In practice, that means - does the bundle of PAYE salary, pension contributions and other benefits that the director is receiving represent a reasonable bargain for the work being done, or is it excessive?

For a typical fee-earner, generating the company’s income, it’s almost certainly going to be fine. If your company is making enough money to sustain £12,000 of salary plus £40,000 of pension contributions a year, a £52,000 “package” is unlikely to be excessive and there should be no trouble with the company getting tax relief.

A fairly common question from people already doing that is - can I do the same for my spouse or partner too? That’s much more problematic. If they’re doing no work for the company, then a package of £1 would be excessive, let alone any greater amount! If they’re doing some work, you’ll have to take a position on whether the proposed contribution would meet that “wholly and exclusively” test, when considered alongside any PAYE salary also being paid.

In practice, this tends to mean that for fee-earners, big contributions are fine, whereas for a spouse doing some admin support, say, material contributions aren’t really defensible (and there would instead be an argument for their being taxable as income on the director instead!). It’s easy to get confused about the mechanical “how much can go into the pot” rules, and overlook that aspect.

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Should I make pension contributions personally or via my limited company?

Generally, via your limited company.  An exaggerated example explains why.

Imagine it’s the evening of the last day of your company year, and you’re so keen to get your year-end accounts done that they’ve been drafted already.  You can see you’ve got £10,000 of profits.  You’d like to get that into your pension pot.  There are two ways you could achieve that.

The first is for your company to make an employer contribution directly to your pension fund of £10,000.  That reduces the company profits and tax bill to zero (if you do it before midnight, anyway!), and gets £10,000 into your pension pot at a cost of £10,000.

The second is to take a dividend and make the pension contribution yourself.  If you decide to do that, you know that the company will have £1,900 of corporation tax to pay on its £10,000 of profits, so you take the maximum legally permitted dividend of £8,100, once more leaving the cupboard bare.  You contribute that £8,100 to your pension personally.  There’s basic rate tax relief on it, which means that the government gives the pension company another £2,025.  You’ve got £10,125 in your pension fund - that’s better, right?  It is until you do your tax return and have to pay tax on the dividend.  Assuming it sits in your basic rate tax band you’ll pay £700 of tax on it, so actually it’s cost about £10,700 to get that £10,125 into your pension pot (and there’s a similar marginal cost if the dividend is taxed at higher rates too, as higher dividend tax and greater tax relief cancel each other out).

One small caveat.  If you’re thinking of applying for a mortgage or a remortgage, you might choose to take higher dividends and make personal contributions, even though you’ll wind up a bit poorer that way.  That’s because it will maximise your personal taxable income, and that’s what a lender looks at when deciding how much to lend to you. But if you’re looking for the biggest pension pot at the lowest cost, company contributions are the way to go.

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What’s the pension annual allowance?

“How much can I put into my pension this year?” sounds like quite a simple question, doesn’t it? Often, though, our job is to point out that a question that quite reasonably seems straightforward is not. This is often one of them!

One of the overarching concepts with pensions is the Annual Allowance. This is generally thought of as “how much can I contribute to my pension each year?”. But it’s not as simple as that. A better way of thinking of it is “what’s the most money that is allowed to make its way into my pension pot this year?”. Because personally contributing isn’t the only way money can get into your pension. There are really three:

1. You can make a contribution personally into your own pension scheme (by, for example, contributing to a personal pension or an Automatic Enrolment one - a Defined Contribution scheme, where there's a visible pot that's yours; the vast majority of pensions these days).
2. Your employer (which might be your own limited company) can similarly make a contribution into a scheme.
3. If you’re in a Defined Benefit scheme, where there’s no discrete personal pot of savings but your employer promises to pay you a pension once you retire, from their pension fund as a whole, then your employer can increase the pension it promises to pay (this happens a lot with NHS consultants, whose promised pension increases each year with longevity and seniority). That’s deemed to be an increase of a notional pension pot, counting towards the Annual Allowance and the employer must quantify it for you.

Fundamentally, we all have an Annual Allowance of £40,000, and that's the total cap on those three things put together. But there are still complications:

• The Annual Allowance is reduced if your income for the year is over £240,000 (previously £150,000).
• If you’ve not used up all your Annual Allowance in the previous three years, that’s usually added to this year’s allowance too. So, in an extreme case someone could have £160,000 legitimately make its way into their pension funds this year.

We’re not done, though. The Annual Allowance is simply a ceiling on what can go in by one route or another. But there are separate limits on what can go into personal pension funds via those first two routes:

• Although anyone can contribute up to £3,600 to a personal pension in a tax year, above that the amount you can contribute personally is capped at your “Relevant Earnings” - basically, your income from a PAYE job or an unincorporated business. So even if someone has Annual Allowance of £88,000 available because they’ve got some unused AA from earlier years, if their income for this year is £42,000 via PAYE then the maximum personal contribution they can make is £42,000 (even if they’ve loads of spare cash beyond that). Directors on a small salary therefore can't pay much into their pension personally. (It’s also important to remember that personal pension contributions are made net of basic rate tax, so if that person wants to contribute £42,000, they’ll actually hand over £33,600 to the pension company, who’ll get the other £8,400 from the government).
• The amount your employer can pay into your pension needs to be justifiable in terms of the total “package” you get from them (otherwise it’s not a legitimate deduction against tax for them). If your employer is just a third party, that’s going to be the case automatically; the whole reason they’re giving you that salary, pension contribution etc is because they think it’s an appropriate economic bargain for your services. When it’s your own company it needs more thought. If you work through your own company, is it reasonable for your company to put £40,000 into your pension? Generally, yes. It’s likely that, in conjunction with the small salary you’re getting, the total package wouldn’t be considered excessive, as you seem to be generating enough value for the company that it can afford the package. So this is how most director-shareholders fund their pension; their contributions aren’t capped at their small salary, because they’re not making personal contributions. Would it be reasonable for the company to make a similar payment into the pension of a non-working spouse? No. If they’re not working for the company, the appropriate employment package for them would be zero.

It’s even harder if you’re in a defined benefit scheme - you won’t know about the deemed increase in your pot until after the year-end, at which point it’s too late to make any further contributions for the year! The uplift might be less than you thought, and you’d have liked to have put another £5,000 into another personal pension you have - unlucky! The unused Annual Allowance will have been carried forward to use in the next year, though (if income and so on permits).  Or the uplift might be more than you thought, taking you over the Annual Allowance you have available - in which case you've tax to pay.

Pensions are pretty simple for many, but not for everyone!

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When might directors pause their employer pension contributions?

Imagine your company has a 31 March year-end.

Are you going to make an employer pension contribution in March 2023?  Probably not.  If you make the contribution in March 2023, it’s going to save corporation tax at 19%.  If you wait one month (one day, even) until April 2023, it’ll save corporation tax at the new rate of 25% (albeit 12 months later, but it’s still a guaranteed 6% return).

Are you going to cancel a planned contribution this month, and wait until April 2023 and the greater tax saving?  Probably not - on average, 25 months of tax-free investment growth would be likely to outstrip the 6% tax difference.

Are you going to make an employer pension contribution in February 2023?  Probably not. If you wait two months until April 2023, it’ll save corporation tax at the new rate of 25% rather than 19%.

Are you going to cancel a planned contribution next month, and wait until April 2023 and the greater tax saving?  Probably not, it’s fair to think that 24 months of tax-free investment growth will still have a fair chance of outweighing the 6% tax difference.

There’s a point somewhere in between where might choose to pause contributions, though.  Over the long term, the profits in your company above and beyond what you pay yourself are going to be split in some fashion between pension contributions and building up reserves in the company.  Mathematically, you'd ideally do the former when the corporation tax rate is 25% and the latter when it’s 19%.

Of course, this interesting dilemma presupposes that there will be no changes to the other rules and limits on pension contributions between now and 2023-24.  Historically, that's often been a reckless assumption!

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Could you benefit from unlocking your pension Annual Allowance?

We’re big advocates of regular monthly saving if you’re looking to build up cash and other investments for the future. Generally people find it much easier to save a little bit each month, rather than waiting and hoping to save bigger lump sums from time to time. However, there are times when an opportunity to save a one-off large sum comes along – perhaps because of an inheritance, a bonus from work, or a redundancy payment. It’s not unusual in those circumstances for people to consider making a large pension contribution. It can also be an attractive option for limited company owners if they’re having a particularly profitable year.

An important thing to keep in mind, though, is that there’s a limit to how much you, your employer or your own limited company can contribute to your pension pot each year without attracting a tax charge. For most people, that limit is £40,000, though it can be as low as £4,000 for people with very high incomes. The £40,000 limit means that most of us don’t need to give any thought at all to the level of day-to-day pension contributions we’re making. But someone considering a large one-off contribution might need to keep it in mind.

The good news is that you can generally use any unused allowance from the previous three tax years as well as the current year allowance, so that can be very helpful if, say, you want to put £70k into your pension fund all in one go. However, you can only do that if you were a member of a registered pension scheme in those earlier tax years. So in practical terms, if you think there’s any chance that you might have an opportunity to make a large pension contribution at some point in the future, it could be a good idea to open a pension scheme right away if you don’t already have one, to effectively unlock the annual allowances for the intervening years and make them available to carry forward.

As ever, an IFA is the person to talk to if you’re thinking of investing in a pension. Although we can help with the tax aspects, we’re not authorised to give investment advice, so we’d definitely recommend speaking to an IFA if you think you might want to make large pension contributions in the future.

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What's a Personal Pension?

As accountants, we deal with the increasingly complicated world of pensions every day. But although it's all (fairly) clear to us, it's actually an area that's obtuse and intimidating to many people. So here's a primer on the basics of how personal pensions work!

A personal pension is just a tax-advantaged method of saving for retirement. The good thing is that the government will add something to the pot in addition to whatever you save, and the contents of the pot can grow tax-free. The bad thing is that the price you pay is being unable to get your hands on any of the money until you're at least 55 years old.

How much can I save into my pot?

Fundamentally, the maximum contribution (the Annual Allowance) in a year is £40,000. It's more complicated than that, though. That £40,000 allowance starts to get reduced if you have income greater than £150,000, and if you have income greater than £210,000 your Annual Allowance is only £10,000. But you can generally carry forward unused Annual Allowance for up to three years, so in certain circumstances someone might be able to contribute £160,000 in one go!

Although getting 20% tax relief on contributions generally relies on having enough income that you've actually paid a matching amount of tax, anyone can contribute £3,600 in a tax year, even if they're paying no tax at all.

So, how does this tax relief work?

For every £80 you put in, the pension company asks the government for a further £20. So that means you've £100 in your account, and you're out of pocket by only £80. That's basic rate tax relief (i.e. you've saved 20%).

Should I put the contributions on my tax return?

If your income is below £50,000, nothing happens, so including the contributions won't make any difference to your tax bill. Your income has topped out in the basic rate tax band where tax is charged at 20%, and you've had all the tax relief you're due.

But if your income is above £50,000, you'll save some more tax. If someone who has contributed that £80 to their pension is in the higher-rate band, the government will knock another £20 off their tax bill. So now they've got £100 in their account and are only £60 out of pocket. That's higher-rate tax relief (i.e. you've saved 40%).

You can save even more if your income is in a higher tax bracket.

What about if I work via my own limited company?

In that case, it's generally marginally better for the company to make contributions directly to the pension company as your employer, rather than you making them personally.  The company puts the whole amount into the pension, and its corporation tax bill is reduced as a result.  It's vital that the pension company knows they're receiving an employer contribution rather than a personal one, though.

Where do I get a pension?

There are lots of providers. Because we're not Independent Financial Advisers (IFAs), we're not allowed to tell you exactly where to put your money, though we've some more content we can share about the options and what we see people doing. For personal advice, we've a handful of IFAs who trust and are happy to recommend.

What happens to my money whilst it's in my pension?

It'll generally be invested in something - funds, shares, bonds, that kind of thing.

In the simplest, cheapest products that may simply be done for you, based on your age and anticipated retirement date. Broadly, the younger you are, the riskier the investments will be - since you've a long time horizon, more volatile investments with a greater anticipated long-term return are likely to be more appropriate than something more steady and boring. As you approach retirement, they'll be gradually switched into less volatile investments - it's a process known as lifestyling.

At the other end of the spectrum, some people like to actually pick and choose their own investments within the pension, or have an adviser do it for them. And there are points in between where you can make high-level choices but leave the detail to someone else, or to a robot.

How do I get money out of my pension?

It'll depend on the rules when the time comes. They're quite different now to the way they were 10 or 20 years ago, and you can expect them to be different in the future too. The general shape of things at present for most people is that you can get 25% of the pot tax-free, then as you draw out the remainder you'll pay tax on it as part of your income as you take it. If someone can save 40% tax when they contribute, grow their pot tax-free, and then get a quarter of it out without paying any tax and potentially pay tax at no more than 20% on the rest, that could be pretty attractive.

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