We all want the peace of mind that comes from knowing we’ll be comfortable in the future. That’s why it’s never too early to start thinking about your pension. Pensions can seem incredibly complicated at first, but it’s worthwhile to take some time to get your head around your policy and what you’re able to contribute.
Read on for information about how pension contributions work in the UK.
How Much Can You Pay In?
In the UK and as a taxpayer, there’s no limit on the amount of money you can pay into your pension each year. Great news if you want to build up a substantial pension pot for the future!
Where limits do exist, they apply to tax. Contributions to your pension are incentivized by tax relief; however, if your contribution exceeds the allowance set by the government (right now, this is £40,000) or the amount of your annual salary, then you’ll be subject to an allowance charge that aligns with income tax rates.
If you want to avoid this charge, make sure your contributions don’t exceed the annual allowance.
Making the Most of Your Allowance
The government grants tax relief whenever you make contributions to a pension, and it’s up to you how you use this. You might choose to channel it into your pension pot for the future or you might enjoy a tax reduction right now. Check what kind of policy you possess to see if there are rules and regulations about this.
Another option you may wish to explore is to carry forward unused allowances from previous years. Under certain circumstances, you’re entitled to do that from the previous three years. That could add as much as £120,000 to your annual tax-free contribution allowance.
Contributions That Count Towards This Limit
Remember, the annual pension allowance of £40,000 includes employer contributions and tax relief received as well as personal contributions.
Bear in mind that the government sets a minimum for total contributions as well as a maximum one. At the moment, the minimum is 8% of your income. This doesn’t necessarily apply if you are a freelance worker or if your earnings don’t reach a certain level.
Of this 8%, your employer should contribute at least 3%. If their contribution doesn’t meet the minimum required, you’ll have to cover the difference. You may choose to use the tax relief you receive on your contributions to save more.
To avoid exceeding the annual contributions limit, keep a close eye on your contributions as well as those of your employer.
Why Might Your Allowance Be Lower?
Right now, the annual contributions allowance is £40,000. If you exceed this allowance, you will be charged according to income tax rates.
The exception to this rule is if you have an income of over £240,000. Your annual pension allowance may be reduced in this instance.
If you’re an additional rate taxpayer, then your annual allowance will be reduced by £1 for every £2 that you earn over £150,000. To put this in context, in 2019, there were only 321,000 people in the UK earning more than £150,000 a year.
Your allowance cannot be reduced more than £36,000, no matter how much you earn. That means the annual contributions allowance will never be lower than £4,000, even for the highest earners.
Tax Relief on Your Contributions
Tax relief is available on private pension contributions to the value of up to 100% of your annual earnings. This is applied automatically when your employer takes workplace pension contributions from your pay before income tax is deducted.
It’s also applied automatically when your income tax rate is 20%. In this scenario, your pension provider makes a tax relief claim and adds this amount to your pension pot. This is called relief at source.
In Scotland, your rate of income tax may be 19%. However, your pension provider can still claim tax relief on your behalf at a rate of 20%. There is no need for you to make up the difference.
If you have an overseas pension scheme, UK tax relief may still be available on your contributions. However, it’s your responsibility to ensure you don’t receive tax relief on any contributions that exceed your annual earnings. In that scenario, HMRC is entitled to demand this be repaid.
There isn’t just an annual pension allowance; there’s also a lifetime one. This limits the value of the pension benefits that you can receive throughout your life without having to pay additional tax.
The lifetime allowance is subject to change, but for the year 2021/22, it is set at at £1,073,100. This is likely to increase in future.
What happens if you you exceed the lifetime pension allowance? Well, you’ll be subject to tax whenever you remove the excess benefits from your pension. This will be a 25% tax if paid as a pension or a 55% tax if a lump sum. The standard rate of income tax will also apply!
How Much Should You Contribute
People have different opinions on how much you should contribute to your pension. Some people say as a rule that you should take the age you start paying your pension and halve it to find the percentage you should pay until each year of retirement.
If you’re in debt, however, it may be prudent to pay that off first – especially if it’s subject to a high interest rate.
How Much Can an Employer Pay In?
If you meet the salary threshold of £520 a month, £120 a week, or £480 over 4 weeks then your employer must pay a minimum of 3%. They do not have to contribute anything if you earn less. The minimum percentage is higher for most defined benefit pension schemes.
How an Employer Contribution Works
When you are automatically enrolled into a pension by your employer, there are minimum contribution levels set by law. The amount your employer contributes towards the pension depends on the type of workplace pension policy that you have.
Ask your employer about the rules: contributions vary depending on whether you were automatically enrolled or you opted in as well as what counts as earnings under their particular rules.