The pension savings annual allowance

The pension savings annual allowance for tax relief on pensions has been fixed at £40,000 since 6 April 2014. The annual allowance is further reduced for high earners. Since 6 April 2020, the tapered annual allowance increased from £150,000 to £240,000. 

This means that anyone with income below £240,000 is not affected by the tapered annual allowance rules. Those earning over £240,000 will begin to see their £40,000 annual allowance tapered. For every complete £2 income exceeds £240,000 the annual allowance is reduced by £1. The annual allowance cannot be reduced to be less than £4,000. The annual allowance can also be affected if the taxpayer flexibly accessed their pension pot.

There is a three-year carry forward rule that allows taxpayers to carry forward unused annual allowance from the last three tax years if they have made pension savings in those years. The calculation of the exact amount of unused annual allowance that can be carried forward can be complicated especially if subject to the tapered annual allowance.

There is also a pensions lifetime allowance that needs to be considered. The limit is currently £1,073,100.

Tax when you get your pension

There are special rules which allow individuals who have set up private pension scheme(s) to benefit from significant tax reliefs when saving for their retirement. There is no overall limit to the amount of employer or employee contributions and no upper limit to the total amount of pension saving that can be accumulated. However, there are important limits that affect the tax reliefs available. For example, you will usually need to pay a tax charge if your private pension pots total more than £1,073,100. There will also be tax to pay if your pension contributions exceed £40,000 in any tax year, unless covered by unused relief from the previous three years, (this £40,000 limit may be reduced for high income earners).

Certain pension benefits can be taken tax-free. In general, you can take 25% of your pension pot as a one-off lump sum without paying tax but the remaining 75% must be used to buy an annuity, to secure an adjustable income or taken as cash (with tax due on the balance). You can also take smaller cash sums from your pension pot and 25% of each chunk would be tax free.

However, it is important that taxpayers are aware of the tax position when receiving pension income. Apart from the special tax-free benefits, pension income is treated as earned income for Income Tax purposes and any Income Tax payable is calculated as per the usual rules. The personal allowance for the current tax year is £12,570. There is no liability to pay National Insurance contributions on pension income.

Income Tax is also due on the State Pension, earnings from employment or self-employment and any other taxable income received.

Pensions triple lock to be reinstated

The triple lock guarantee on pensions that was suspended for the current 2022-23 tax year is to be restored from April 2023. In September 2021, the government announced that its triple lock guarantee on pensions was to be abandoned for one year due to unprecedented fluctuations to earnings caused by the COVID-19 pandemic.

The triple lock guarantee was first introduced in 2010 and had remained in place until April 2022. The guarantee had seen the full yearly State Pension increase by over £2,050 in this period. The triple lock is the mechanism used to calculate increases to the state pension each year. Under the triple lock guarantees the basic state pension rises by whichever is the highest out of average earnings growth, inflation or 2.5%.

The confirmation that the government will reinstate the triple lock from April 2023 means that the state pension increase will be based on the reading of the consumer price index (CPI) for September 2022. Based on current forecasts this is likely to be significantly higher than the forecast inflation rate for 2023-24 and likely to be in the range of a 10% increase. 

The change was announced in Parliament by the Chief Secretary to the Treasury and remains subject to the Secretary of State’s review. This decision will bring some cheer to many of those in receipt of the State Pension especially following the changes this tax year and the inflationary pressures affecting the real value of their pension. 

Changes in State Pension age

The State Pension age is currently 66 and two further increases are set out in legislation: a gradual rise to 67 for those born on or after April 1960; and a gradual rise to 68 between 2044 and 2046 for those born on or after April 1977. 

In March 2016, John Cridland CBE, the former Director General of the Confederation of British Industry (CBI) was appointed by the government to lead an independent review of the state pension age. The review made a number of key recommendations including bringing forward the increase in the State Pension age to 68 over a two-year period starting in 2037 and ending in 2039.

The Department for Work and Pensions has previously confirmed that the Government intends to follow the recommendation made by the independent review to bring forward the State Pension age changes, seven years earlier than planned. The Pensions Act 2014 requires government to regularly review State Pension age, and in accordance with this law, the latest Review must be published by 7 May 2023.

These proposed changes will not affect anyone born before 5th April 1970. However, those born between 6 April 1970 and 5 April 1978 would see their State Pension age increase to between 67 and 68 depending on their date of birth. Those born after 6 April 1978 will see no change to their state pension age which was already set at 68. These changes will require new legislation following the next government State Pension age review.

The independent review also cited some interesting background information addressing the need for these increases to be based on increasing life expectancy and an ageing population. For example, '…. in 1917 King George V sent the first telegrams to those celebrating their 100th birthday. 24 were sent that year. In 2016 around 6,000 people will have received a card from Her Majesty the Queen. In 2050, we expect over 56,000 people to reach this milestone'.

Auto enrolment for care workers

Automatic enrolment for workplace pensions has helped many employees make provision for their retirement, with employers and government also contributing to make a larger pension pot.

The law states that employers must automatically enrol workers into a workplace pension if they are aged between 22 and State Pension Age and earn more than minimum earning threshold. The minimum threshold has remained fixed at £10,000 since 6 April 2014. The employee must also work in the UK and not be a member of a qualifying work pension scheme. Employees can opt-out of joining the pension scheme if they wish.

These rules apply if you directly employ a care worker to provide you with care and support, often called a personal assistant or a personal care assistant. It is important to note that you will be classed as an employer whether or not you pay using money provided by your local authority or the NHS in the form of direct payments or a personal budget to pay your personal care assistant, or if you use your own money.

The main exception to this rule is if the care worker is provided by an agency, and the agency pays the personal care assistant’s National Insurance contributions. If this is the case, then the agency will be responsible for the automatic enrolment requirements.

Pension triple-lock abandoned for one year

The government has confirmed that its triple-lock guarantee on pensions is to be abandoned for one year. The guarantee was first introduced in 2010 and has remained in place until now. This guarantee has seen the full yearly State Pension increase by over £2,050 in this period.

The triple-lock is the mechanism used to calculate increases to the state pension each year. Under the triple-lock guarantees the basic state pension rises by whichever is the highest out of average earnings growth, inflation or 2.5%.

The government is concerned that the growth in earnings will be between 8% and 8.5% and has decided that setting aside for one year the use of average earnings growth figures for State Pensions would be prudent. This large growth figure has been caused by the unprecedented fluctuations to earnings caused by the COVID-19 pandemic.

The other two elements of the triple-lock will remain in place, meaning that the State Pension will be uprated by the higher of inflation or 2.5%.

The government has argued that this pause in the triple-lock is the fairest approach for both pensioners and younger taxpayers. However, this decision will leave many of those in receipt of the State Pension deeply disappointed with this decision and worried that this is the start of further broken promises.

It had been rumoured for quite some time that HM Treasury was exploring ways to suspend the triple-lock as it became apparent that the earnings growth figure would appear to be artificially high.

Covering pension contributions with unused allowances

The annual allowance for tax relief on pensions is currently set at £40,000. The annual allowance is further reduced for high earners. This means that if your income is in excess of £240,000 you will usually begin to see your £40,000 annual allowance tapered. For every complete £2 your income exceeds £240,000 the annual allowance is reduced by £1. The annual allowance can also be reduced if you have flexibly accessed your pension pot.

If you have not used all your annual allowance in a tax year, then the unused allowance can usually be carried forward to the current tax year and added to the current year’s annual allowance. The calculation of the exact amount of unused annual allowance that can be carried forward can be complicated especially if you are subject to the tapered annual allowance. 

Normally, you can carry forward unused allowance from the three previous tax years. You do not need to report this to HMRC. If you have unused annual allowances from more than one year, you need to use the allowance in order of earliest to most recent. Any remaining balances can be used in future tax years, subject to the usual time limits. You do not need to report this to HMRC.

HMRC’s pension calculator can also help you check if you have any unused annual allowance to carry forward.
 

What is net income for pension relief purposes?

The lifetime allowance is the maximum amount of pension and/or lump sum that benefits from tax relief. The lifetime allowance is currently set at £1,073,100. The annual allowance for tax relief on pensions is currently £40,000 and there is a three year carry forward rule that allows taxpayers to carry forward unused annual allowance from the last three tax years if they have made pension savings in those years. 

If you have a reduced (tapered) annual allowance the first step is to calculate your net income. Your net income is your taxable income for the year less any tax reliefs such as payments made to your pension scheme that had tax relief but were paid before the relief was applied. You will also need to quantify your pension savings, threshold income and adjusted income.

Those with an adjusted income over £240,000 will begin to see their £40,000 annual allowance tapered. For every complete £2 income exceeds £240,000 the annual allowance is reduced by £1. In recent years, both the annual and lifetime allowances have been gradually reduced removing the amount of tax relief on pensions available to high earners.

Added protection for pension savers

The new Pensions Scheme Act received Royal Assent on 11 February 2021. The Act covers a number of important pensions-related issues and has faced a long journey through parliament, starting in October 2019, that included delays due to both Brexit and the coronavirus pandemic.

The Act has been described by government as ‘the biggest shake-up of UK pensions for decades. The Act will provide for enhanced powers for the Pensions Regulator, including the power to impose civil penalties of up to £1 million and three new criminal offences.

One of new criminal offences, that could result in up to seven years in prison, will target bosses who run pension schemes into the ground, or plunder pots to line their own pockets. This is expected to strengthen the regulators’ powers to take efficient and timely actions to protect members’ hard-earned savings.

The legislation also introduces a new pensions dashboard creating one single platform to access and review pension pots, and the creation of new style collective defined contribution (CDC) schemes. CDCs have the potential to increase returns for millions, whilst being more sustainable for both workers and employers.

The Act also aims to ensure that pensions help with climate change governance by moving towards a net zero future through climate risk reporting.

The measures in the Act will come into force at different times as secondary legislation is introduced.

Tax on an inherited private pension

Private pensions can be an efficient way to pass on wealth, but it is important to consider what, if any, tax will be payable on an inherited private pension. The person who died will usually have nominated the recipient by telling their pension provider that they should inherit any monies left in their pension pot. If the nominated person can’t be found or has since died, the pension provider may make payments to someone else instead.

In general, if you inherit a private pension and the owner of the pension fund died before the age of 75, the benefits left in a private pension can be paid as a lump sum or as drawdown income with no tax to pay. If the deceased passed away after the age of 75 the pension will be taxed at your marginal Income Tax rate, so 20% if you are a basic rate taxpayer or 40% if you are in the higher tax bracket and 45% if you pay tax at the top rate. The rates may differ if you are a Scottish taxpayer.

There are restrictions on pensions from a defined benefit pot (usually workplace pensions) whereby the pension can usually only be paid to a dependant of the person who died, for example a husband, wife, civil partner or child under 23. This rule can sometimes be changed if the pension fund allows, but the inheritance will be taxed at up to 55% as an unauthorised payment.

The rules on inheriting a pension are complex and depend on what type it is and how old the holder was when they died. For example, you may also have to pay tax if the pension pot owner was under 75 but had pension savings worth more than £1,073,100 (the lifetime allowance) when they died. There are also important time limits that must be followed.