Tag Archives: Tax Relief

Retirement planning in 2022/23

As we welcome in a new tax year, here’s a look at pension planning for 2022/23.

Now that all the last-minute end of tax year pension planning is complete it is time to turn to 2022/23 and consider any changes that apply when advising on pension funding or taking benefits.

Although the pension tax regime has remained relatively stable over the last few years a new tax year always brings a few changes along with a fresh set of allowances to make the most of.

The main impact on pension funding is an indirect one – the increase in the National Insurance Contribution (NIC) rates and the accompanying increases in the dividend rates. Both these changes can make the advantages of pensions even greater in two key areas of pension planning:

Salary sacrifice and pensions

Employees can sacrifice part of their salary and/or bonus in return for their employer paying the amount sacrificed as an employer pension contribution on their behalf. Unlike salary/bonus, an employer pension contribution doesn’t attract NIC.

The 1.25% increases in employer and employee NICs makes salary sacrifice even more attractive. As well as the usual income tax relief, the additional benefit of salary sacrifice is the NICs savings for both employer and employee, made by reducing salary. Employers make their own decisions of how much of the NIC saving they pass onto their employees, with some passing all and some nothing at all. However, even if none, the employee will still benefit from their employee NICs savings.  

The benefits of salary sacrifice from 2022/23 onwards will be even greater. For employees, they will save an additional 1.25% on any of their earnings they choose to give up. Employers will save the same and may be willing to pass some or all of this onto the employee. This may lead to an increase in contributions via salary sacrifice and more employers wanting to set up salary sacrifice arrangements.   

The Government largely withdrew the income tax and NICs advantages where benefits in kind are provided through salary sacrifice arrangements (described in the legislation as ‘optional remuneration arrangements’) from 6 April 2017. However, pension contributions were exempted from that change.

The significant advantage may cause the Government to take another look at salary sacrifice arrangements, particular from next year where the tax becomes a separate charge, i.e. The Health and Social Levy. However, we are yet to see any signs of this, so it is unlikely that anything will change for this tax year at least.

Profit extraction from owner-managed limited companies           

For those in control of how they distribute funds from their company there are broadly there three main ways to extract the funds – either as salary, dividends or by making employer pension contributions. The increase in the NIC rates and dividend tax rates both make the extraction of profits via pension contributions more attractive. 

To provide a shareholding director with their immediate income needs, the company accountant will often suggest paying a minimal salary, perhaps up to the personal allowance (or in previous years the employer NICs secondary earnings limit) and the rest in dividends. As the rate payable on both the employer and employee NICs will have increased by 1.25%, this is unlikely to change, despite the increase in dividend tax rates. Therefore, advisers will usually be comparing paying further dividends with employer pension contributions at the director’s marginal rate of tax. 

Any further dividend payments will effectively result in additional corporation tax (because dividends are paid out of after tax profits) and the recipient will suffer higher dividend tax rates (assuming the tax free dividend allowance has already been used up) of 8.75%, 33.75% and 39.35%.

In contrast, a pension contribution can be made gross, and, providing it meets the usual “wholly and exclusively” rules, will be treated as a business expense. There will, of course, be tax when the pension is paid, but 25% of this is normally paid free of tax and the rest subject to income tax at the recipient’s marginal rates of income tax at the time.

Maximising allowances

Elsewhere, the main rates of tax relief on contributions, as well as the annual allowances, remain unchanged. For those unaffected by tapering or unrestricted by the money purchase annual allowance this is generally good news, with the £40,000 allowance providing adequate scope for most to make reasonable pension provision.

The personal allowance and the basic rate tax band remain unchanged at £12,570 and £37,700 so, for those in the decumulation phase, unfortunately, there is no scope to increase tax efficient income payments within these bands where they are already being fully utilised. However, for clients in the decumulation phase, the start of the tax year is a good time to review the most tax efficient way of taking money from their pension pots.

With the freezing of the tax bands and relatively high inflation it is likely that many more clients will fall into the “60% band” where income between £100,000 and £125,140 is subject to this very high marginal rate of tax. Pension contributions remain a very attractive option to reinstate the personal allowance and reclaim this tax. For someone earning £125,140 a pension contribution of £25,140 can be made at a net cost of just £10,056.

In terms of carry forward, the relevant carry forward years are now from 2019/20 and anything from previous tax years is no longer available. However, you can’t completely ignore prior years as they may be needed to offset any excesses in the three previous tax years. Remember, for the purposes of carry forward, the income in the previous tax years is only relevant where tapering applies. It is not possible to carry forward earnings.

In relation to tapering, we enter the third tax year with the higher Threshold and Adjusted Income limits of £200,000 and £240,000 respectively. Whilst this should mean far fewer clients are impacted, remember the lower limits of £110,000 and £150,000 still apply when calculating the availability of carry forward for tax year 2019/20 and any of the three earlier tax years where relevant.

Unfortunately, the Lifetime Allowance (LTA), which is frozen at £1,073,100 until the end of tax year 2025/26, remains one of the biggest challenges to retirement planning for affluent clients. For clients approaching or exceeding the LTA the benefits of continuing to fund are far less clear. The LTA can also prompt clients to take funds earlier from their pensions than they would otherwise. This is a particularly complex area of pensions planning and each client’s situation must be considered based on their specific circumstances. There are, though, many cases where funding in excess of the LTA can still provide an overall benefit and accepting the LTA can be a “least worst case” outcome.

The good news is that all the other benefits of pension planning remain in place and, importantly, there’s usually no need to wait until the end of the tax year. Now is a great time to start, or increase, a monthly pension contribution or make a one off lump sum to use up any remaining allowances.

Claire Trott, Financial Planning Week tip: Maximising pensions tax reliefs using carry forward

With the deadline for the Mandatory Pension Savings Statements being this month (6 October) it is now that you can calculate what your clients’ available annual allowance is because the information should now be to hand.

The basics

Carry forward allows clients to utilise unused annual allowances from the previous three tax years. You must first use the current tax year fully and then use the oldest tax year next and so on. The important thing to be sure of is that the client has enough, not necessarily to get too hung up on which year it is used from at this point in time. Exceeding the annual allowance including carry forward will mean tax charges, designed to recoup tax relief given. The tax charge is payable by the member, even if contributions have been paid entirely by the employer.

If total contributions do not exceed the annual allowance including carry forward then there is no need to declare this on a tax return, only contributions in excess of this need to be declared in the pension tax charge section of self assessment. However, for those contributing to a relief at source pension scheme, who are higher or additional rate tax payers they will need to ensure they claim any extra tax relief due. This should be done even if they exceed the annual allowance so as not to be unfairly penalised.

Eligibility

We have to remember that not everyone is eligible for carry forward, they must have been a member of a scheme in the years in which they are carrying forward unused annual allowance.

This doesn’t just mean a contributing member, but also anyone with a deferred pension scheme, such as an old final salary pension or even a contracted out rebate scheme for instance.

But if this is their first pension contribution ever, then carry forward isn’t available. In additional, if the client is subject to the money purchase annual allowance then carry forward is only available in relation to defined benefit accrual.

Limitations

The annual allowance is a test on total pension contributions including personal tax relief received by the scheme and employer contributions, and therefore when carrying forward the annual allowance from the previous three years it increases the total amount of pension contributions that can be paid within the current tax year. What it doesn’t do is bring forward unused tax relief, so for personal contributions there is a limit on the amount of tax relief available equal to £3,600 or 100% of relevant UK earnings within the current tax year. This means that for many they will have significantly more available annual allowance than they can pay with personal contributions alone.

It is important to remember in addition that carry forward isn’t limited by the clients earnings in previous years, so if they had earnings of £20,000 and paid a £10,000 gross personal contributions with no employer contributions then £30,000 carry forward would be available.

Tapered annual allowance

Pension savings statements or contribution histories provided by schemes will not take into account the tapered annual allowance. Schemes are not responsible for this calculation because they do not have sufficient information to do the calculations. Therefore, it is important to fully understand the client’s income, including in previous years. If the tapered annual allowance applied in previous years, it is this figure that will be used in the carry forward calculations, not the standard annual allowance

Comments

There are many moving parts when dealing with tax relief on pension contributions which are important to understand. My colleague Chris Jones provided some tips earlier in the week on “Making the most of pensions tax relief ahead of another Budget” which covers many of these complex aspects and so worth a read.

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The Future of Pensions Tax Relief

Change seems inevitable, the direction of travel seems clear – what can we expect when we get more detail at the next Budget?

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To access your free trial; go to www.techlink.co.uk/freetrial and request which trial option you require from the options shown. You will then be given 4 weeks free access to Techlink Professional and/or Techlink Communicator and an example of the Communicator content.