Now may be the right time to play catch up for any individuals who’ve neglected their pension savings in recent years or have relied solely on their employer’s scheme to provide for them in retirement.
The new pension freedoms have provided a fresh incentive to save for retirement. Unlimited access without the need to buy an annuity and the inheritability of pension wealth are just some of the reasons why some people have rekindled their interest in pensions.
This could open up a new seem of individuals looking at ways to maximise their pension contributions. And it may be an opportunity to move some of their existing savings into a more tax efficient home.
Best of both worlds
The new pension freedoms won’t be available to defined benefit (DB) scheme members. But they could still enjoy the best of both worlds – the guarantee and income security of the DB promise and also using carry forward to save extra into a defined contribution (DC) pension, giving them access to the full range of income options and immediate access from age 55.
Having a secure base line income to cover essential expenditure items but with a fully flexible pot that can be accessed at any time to meet those one-off costs is an ideal scenario.
Going back to carry forward
Using ‘carry forward’ can allow individuals to catch up on contributions from earlier years and allow them to build up a fund which will allow unrestricted access after age 55, with opportunities to pass their wealth to future generations in a tax efficient way.
Unused allowances can be carried forward for up to three years provided the individual was a member of a registered pension scheme in those years. There’s no requirement to have made a payment, nor even have any earnings, during a tax year in order to carry forward from it.
Some individuals could enjoy pension payments as large as £230k, without having any annual allowance tax charge. This can be done by combining the maximum carry forward amount with the current year’s allowance and bringing forward the allowance for 2015/16.
Of course to make a personal contribution of that size also requires earned income to also be at least £230k for the tax year it is to be paid in. This leaves funding of these amounts open mainly to business owners who can redirect business profits towards their pensions instead of paying as salary or dividends. Something we will look at in more detail in a future insight.
Many clients will have neither the salary nor available allowance to pay as much as £230k this tax year. But there may still be enough scope to give their pension savings a welcome boost.
What about carry forward and DB members?
Many high earning public sector workers, including doctors, dentists, lecturers and senior civil servants may have been hit with pay freezes in recent years. Even in the private sector pay has typically been lagging behind inflation.
But this could actually mean there may be a pleasant surprise for some DB members in terms of how much more they may be able to pay because of the way their unused allowance is calculated.
It’s not the contributions paid in the tax year which are tested against the annual allowance; it’s the value of the increase in benefits over the year.
This is calculated by multiplying the opening and closing accrued pension values by 16, with any separate lump sum added at face value. The opening value is then adjusted by inflation. The difference between the resultant opening and closing figures is the input amount.
This is easier to understand by looking at an example.
Example – Robert is a member of a DB scheme providing a pension of 1/60th of pensionable salary for each year of membership.
Over the pension input period ending November 2014, Robert completed 26 years pensionable service and his pensionable salary increased from £97,000 to £100,000. His employer pays a contribution of 25% of salary and Robert pays a personal contribution of 10% of salary – a total contribution of £35,000. But that’s not the amount that’s tested – his pension input amount for the 2014/15 tax year will be calculated as follows:
|Start of input period||End of input period|
|Pensionable service completed (years)||25||26|
|Accrued pension multiplied by a factor of 16||£646,672||£693,328|
|Opening value £646,672 revalued by CPI (Sept 2013, 2.7%)||£664,132|
|Value for testing against the annual allowance||£29,196|
|Remaining annual allowance (2014/15)||£10,804|
If Robert set up a SIPP and paid the remaining allowance of £10,804, it would use the rest of his 2014/15 allowance. But he’d still be able to use carry forward from the three previous years.
Robert had been on a pay freeze for the previous three years. As a result, his pension inputs for the tax years 2013/14, 2012/13 and 2011/12 were £12,209, £0 (his actual accrual for this year was below inflation) and £8,220. This means he could carry forward a total of £129,571.
But he doesn’t have the earnings to use the full carry forward amount this year. His maximum contribution this tax year is £90,000. This is his £100,000 salary less his personal contributions to his DB scheme (£100,000 – £10,000).
This would be split £10,804 for the current year and £79,196 to be carried forward from 2011/12 and 2012/13. It means the same exercise can be carried out next year with scope to carry forward the remaining £50,375 of unused allowances from 2012/13 and 2013/14.
Of course, there may be a decision to be made as to where to pay additional contributions. The employer’s scheme may allow for added years to be purchased or an AVC pot from which tax free cash can be taken to avoid the need to commute DB income for cash. These options will need to be balanced against the flexibility that a separate fully flexible DC pot could offer.
The cost of delay
individuals will need help to work out just how much they could pay into their pension. The information gathering needs to start now in order to get the contributions in before April. And remember the cut in the annual allowance from £50,000 to £40,000 this year will see the maximum amount that can be carried forward reduce for each of the next three tax years. Missing the 6 April deadline will mean that your clients could have lost out on extra £10,000 going into their pension.
Source: Standard Life