Looking to maximise tax relief? Top up your pension before 5 April

The tax year end brings all forms of tax planning into sharp focus, particularly maximising pension contributions to ensure available allowances are fully utilised and any unused allowances are not lost after 6^th April.

Any financial advisor will tell you it’s never too early to start paying into your pension fund, but what many don’t necessarily appreciate, is the significant tax savings that can be made whilst also building a secure plan for retirement.

The UK’s income tax approach to contributions is pretty generous, i.e. not only do you get full tax relief at your highest tax rate (up to 45% UK/ 48% Scotland) on qualifying pension contributions, but the fund itself then grows in a completely tax free environment. This includes current exemption from Inheritance tax (IHT), however, Labour have announced their intention to bring pensions into the IHT tax net from April 2027  (see below updates on inheritance tax).

Despite the IHT changes, with UK income tax rates at such elevated levels, paying into a pension that ultimately benefits your future and family, whilst also saving income tax, must surely be seen as a genuine win.

Given the very generous tax relief available on contributions going into a pension, then in order to secure such tax relief, there are unsurprisingly, various limits/ allowances that must be adhered to. For those attempting to maximise their pension contributions, it is essential they are fully aware of the rules.

Annual Allowance

The Annual allowance, set by HMRC, is the most you can save into your pension pot relative to the current tax year. This is £60,000 for 2024/25.  and it applies to all contributions made across all pensions held, whether contributions are paid by you personally or by your employer.

Tapering for High Earners

If you earn over £200,000, the £60,000 allowance is also tapered (reduced), to an amount between £10,000 and £60,000.   Essentially the allowance is reduced by £1 for every £2 of your ‘adjusted income’ that exceeds £260,000. Adjusted income also includes employer pension contributions that have received tax relief at source, e.g. salary sacrifice arrangement.

Note that the annual allowance will not be tapered, if your ‘threshold income’ is £200,000 or less. It is therefore important to determine what your ‘adjusted income’ and ‘threshold income’ actually is in each case. The broad difference between each calculation, is that the threshold calculation requires a deduction for personal pension contributions, i.e. those contributions paid net of basic rate tax. The different income calculations can provide surprising results and so it’s important that professional advice is taken, to ensure contributions are based on the correct allowance calculations.

Already Taken Money Out of Your Pension?

If you’ve already taken money out of your pension, you can still make contributions to a pension and earn tax relief, but you get a lower annual allowance if you want to make further contributions.  In 2024/25 this is £10,000.

Unused Annual Allowance

Any unused allowance can be carried forward for 3 tax years, so if we look at the current tax year 2024/25, you can utilise unused allowances brought forward from 2021/22, 2022/23 and 2023/24. In order to secure this carry forward, you must also have been a member of a registered UK pension scheme during each of those tax years, even if the pension input for that year was nil.

The annual allowance for the current tax year is always utilised against pension contributions first, then the method of set off is essentially first in first out, i.e. the earliest years unused allowance is used first, before the later years.

Net Relevant Earnings

Where you are personally paying pension contributions, you must be able to demonstrate that you have earnings of the same amount to ‘frank’ the gross pension contributions being made in any tax year. If your employer pays the pension contribution relevant earnings are not necessary. If paid personally however, any excess contributions made will not receive tax relief and in most cases, pension funds will insist on issuing refund of contributions that do not receive tax relief.

It follows, that if you are in the fortunate position to have unused allowances brought forward and wish to pay a lump sum into your pension to utilise these allowances, you must also ensure that you have enough earnings to be able to claim associated tax relief.

Tax Charge Where Contributions Exceed Annual Allowances

If you find that you may have exceeded the annual allowance amount (including any allowances brought forward), HMRC will charge tax at your highest rate on the excess and will also expect you to ‘self assess’ this tax charge on your tax return.

This can often happen if you are a member of a Defined Benefit or Final Salary arrangement, where notional pension contributions can be far in excess of what the individual believes is actually being contributed in cash terms.

There is, however, an option available to ask that the scheme pick up this tax charge on your behalf, but only if the charge is in excess of £2,000 and a formal election is made to that effect within the timescale required, which is 31 July in the year following the tax year.

Lifetime Allowance

By way of reminder, the Lifetime Allowance (LTA) was abolished from 6 April 2024 and replaced with the Lump Sum Allowance (LSA) and the Lump Sum and Death Benefit Allowance (LSDBA).

The LSA allows you to take 25% of your pension as a tax-free lump sum, up to a total of £268,275, across all your pensions.  Note, you may still benefit from higher tax-free lump sums if you previously protected your LTA.

The LSDBA permits tax free lump sums and death benefits up to £1,073,100, with any excess taxed at either yours or your beneficiaries’ marginal rates.

A Sting in the Tail….Looming Inheritance Tax Changes to Pension Pots

As things stand, a pension pot generally sits outside of an individual’s estate for inheritance tax purposes (i.e. the pension pot does not attract inheritance tax).  So not only do you get income tax relief on contributions to a pension, but pensions have proved to be an extremely tax efficient way of passing value to the next generation.

Sadly, it this looks like it’s all about to change.  Under draft proposals announced in the October 2024 Budget, from April 2027 any unused pension pot and death benefit will form part of the deceased’s estate for inheritance tax purposes.   The very existence of a reasonable size pension pot will inevitably bring more and more individuals into the inheritance tax regime.  Draft legislation is not yet available, which means we do not yet know the full impact of the change, so please watch this space for further announcements.

From an income tax perspective, if the owner of an uncrystallised pot dies under 75, any payments made from the pension within the next two years are income tax free for the beneficiaries; lump sums and death benefits exceeding the LSDBA will be taxed at the beneficiaries’ marginal income tax rate.  Owners 75 or above, the beneficiaries will be subject to income tax on anything they receive.   We understand that the income tax position will not change.

Other Hints and Tips Ahead of 5 April 2025

• Maximise pension contributions
• Maximise ISA contributions
• Consider tax efficient investments such as EIS or VCTs
• Review the current year capital gains position and crystalise potential losses if you need to reduce the gains
• Consider charitable donations
• Utilise annual inheritance tax annual gift allowances

If you require any assistance with pension planning or tax year-end planning and understanding the various options which are available to you prior to the end of the current tax year, please do not hesitate to get in contact with Lynn Gracie, Paul Halliday, or your usual AAB contact.