In recent years, pension legislation has progressed a great deal and really is not simple! There’s a complex set of rules, get it wrong and the result is a large tax bill. What’s more, the amount you can save into your pension, each year and over your lifetime, is now significantly lower.
However, if you own a limited company you can still very much fast-track your pension. This is an advantage if you have a lower pension value than you would prefer or indeed if you have a special project in mind, such as investing in a commercial property for your business.
The pension lowdown
The annual allowance came into being on the 6th April 2006 with pension simplification. It indicates the maximum amount of pension savings you can make, or your employer can make for you in a tax year, that can benefit from tax relief.
Since 6th April 2011 it has been possible to carry forward any unused annual allowance from the three previous tax years, provided you were a member of a registered pension for those years. This is permitted once all your annual allowance for the present tax year is used up.
The carry forward of unused annual allowance from previous tax years gives you scope for pension contributions above your present tax year annual allowance and therefore bigger pension contributions and more tax relief.
Tapered Annual Allowance
On 6th April 2016 the Tapered Annual Allowance was introduced.
This is a reduced annual allowance if your ‘adjusted income’ is over £150,000 in the tax year. Broadly speaking ‘adjusted income’ is all your taxable income plus all your pension contributions made by you or for you in the tax year.
If your ‘threshold income’ is below £110,000 the tapered annual allowance will not apply. Essentially, threshold income is your income without adding pension contributions made for you by your employer to your income.
My experience is that if you have a profitable business and thus higher tax liabilities, you are more likely to have used your annual allowance carry forward scope.
For this reason, your maximum annual allowance is now limited to the present tax year only and perhaps limited further if you are a high earner, by the tapered annual allowance rules, which were introduced on the 6th April 2016.
In which case, your pension contributions are massively restricted and so too is the opportunity for the income tax and corporation tax relief that you and your business previously enjoyed.
The answer to making pension contributions on a bigger scale is to make pension contributions to buy a specific amount of retirement income, payable to you at your retirement date. This is possible if you are a shareholder of a trading company and are employed by that company.
The maximum annual future retirement income that you can buy in a tax year is related to the £40,000 annual allowance and is equal to 6.25% of the annual allowance. Therefore, each tax year your company can make a pension contribution to buy £2,500 pa of future retirement income.
An actuarial calculation is made to determine the cost of this future retirement income and once done, the pension contribution is made, normally significantly higher than the £40,000 limit, which otherwise applies.
Making a pension contribution in this way can be a one-off single contribution or it can be repeated each year as desired.
Once the pension contribution is made it can be invested in any permitted pension investment, including commercial property and secured loans to your business.
Having a guaranteed amount of retirement income payable to you at your normal retirement age has understandable appeal. That said, you may decide that your preference is to access your pension benefits in a more flexible way, rather than have a guaranteed retirement income. In which case transferring your guaranteed retirement income into a conventional pension plan is an available option at any time, provided you receive specialist pension transfer advice.