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Tech centre - Financial planning bulletin

Pensions planning - contributions and preserving the personal allowance

Jul 11, 2018, 15:18 PM

Summary


Getting the level and timing of pension contributions right can be an effective tool for reducing your clients’ tax liabilities whilst also increasing pension savings for the future. In this article, we look at the use of pension contributions to avoid loss of your clients’ personal allowance, and we illustrate the considerable tax savings this may achieve.

Facts and analysis


Contributions paid to a UK registered pension scheme may help your clients benefit from valuable tax concessions:

  • Pension contributions paid by your clients may qualify for tax relief at their highest marginal rate, and they will not be taxed on pension contributions or benefit accrual funded by their employer – subject to total pension savings not exceeding their available annual allowance.
  • An employer is able to claim Corporation tax relief on pension savings provided for their employees (the ‘wholly and exclusively in respect of UK trade’ restrictions prevent excessive tax relief being available).
  • Pension contributions (paid by your clients or via a salary exchange agreement with their employer) reduce your clients’ ‘adjusted net income’ and may help to avoid loss of their personal allowance.

These concessions mean the level and timing of pension contributions can be an effective tool for reducing your clients’ tax liabilities whilst also increasing their pension savings for the future.

April 2010 – changes to personal taxation

Two significant changes to the tax rules took effect from April 2010, which may have increased your clients’ personal tax liability.

  • An additional higher rate of income tax - 45% on taxable income over £150,000 for the 2013/14 tax year onwards, and
  • A restriction on personal allowances - the value of the basic personal allowance is reduced for those with incomes over £100,000, and reaches nil for those with incomes of £123,700 or more (2018/19 tax year).

The impact of these changes on your clients’ tax liabilities may be mitigated by an increase in pension contributions – paid directly by your clients or funded via a salary exchange arrangement e.g. reducing their income to a lower tax band, or below £100,000, in exchange for increased employer contributions.

‘Adjusted net income’

'Adjusted net income’ is the measure of an individual’s income that is used for the calculation of income-related reductions to personal allowances.

When calculating ‘adjusted net income’ certain deductions are allowed, these include.

  • payments made gross to pension schemes - these could be payments to a retirement annuity contract, or employee contributions deducted from payroll via a net pay arrangement for payment to an employer’s occupational pension scheme, and
  • the grossed-up amount of an individual’s pension contributions which have been paid to a ‘relief at source’ pension scheme – these are likely to be payments made net of basic rate tax to a personal pension plan.

Personal allowance reduction

Any of your clients with an ‘adjusted net income’ which exceeds £100,000 will find their basic personal allowance for income tax reduced by £1 for every £2 that their income exceeds the £100,000 threshold.

  • As the personal allowance for the 2018/19 tax year is £11,850 (for individuals under age 65), this means those with adjusted net incomes of £123,700 or more will have no personal allowance and the whole of their income may be subject to tax.
  • For individuals with adjusted net incomes between £100,000 and £123,700, their personal allowance will gradually reduce to nil as their income approaches the higher end of the scale.
  • Those individuals with an ‘adjusted net income’ below or equal to the £100,000 threshold will continue to be entitled to the full amount of the basic personal allowance.

HM Revenue & Customs (HMRC) guidance on ‘Personal Allowance and adjusted net income‘ and ‘Personal Allowance‘, is available on the HMRC website. This guidance explains what 'adjusted net income' is, and how it may be used to calculate the value of your client’s personal allowance.

Keeping, or restoring, a personal allowance

Salary exchange

  • A salary exchange arrangement involves the reduction of an individual’s salary in return for a non-cash benefit provided by their employer.
  • This may be a means of reducing your client’s salary to (or below) the £100,000 income threshold, with an employer contribution of a similar value being paid to their pension plan.

In addition to restoring their personal allowance, your client may benefit from a higher than expected employer pension contribution - if the employer adds some, or all, of their NI savings to the contribution.

We have considered salary exchange in more detail in the following article:

‘Salary exchange - contribution options'.

Pension contributions

  • An increase in the level of pension contributions paid by your client may bring their ‘adjusted net income’ closer to, or below, the £100,000 personal allowance threshold.
  • This means your client may benefit from regaining part of, or all of their personal allowance . . . and tax relief on their increased pension contributions.

It is easiest to illustrate this with an example:

2018/19 tax year


     

40% tax payer, aged under 65, no pension contribution

 

Income

£123,700

 
      Adjusted net income £123,700 - personal allowance reduced to nil

     

Tax rate

Income

Tax deductions
      0% £ --- £ ---
      20% £ 34,500 £ 6,900
      40% £ 89,200 £35,680
      Totals £123,700 £42,580

     

40% tax payer, aged under 65, £23,700 pension contribution

     

Income

£123,700

 
      Pension contribution £ 23,700  
      Adjusted net income £100,000 - personal allowance £11,850

     

Tax rate

Income

Tax deductions
      0% £  11,850 £ ---
      20% £ 34,500 £ 6,900
      40% £ 77,350 £30,940
      Totals £123,700 £37,840*

     

* £4,740 basic and £4,740 higher rate tax relief on the £23,700 contribution reduces the total tax deductions to £28,360

     

Tax savings

     

£4,740 through the regained personal allowance, plus £9,480 tax relief on pension contributions (40% x £23,700) giving a total tax saving of £14,220

To summarise:

 

No pension contribution

Pension contribution of £23,700

Gross salary

£123,700.00

£123,700.00

Total tax*

£42,580.00

£28,360.00

NI Contributions

£6,098.12

£6,098.12

Gross pension contribution

£0.00

£23,700.00

Net pay

£75,021.88

£65,541.88

*Tax paid, less basic and higher rate tax relief.

After making a £23,700 pension contribution, the reduction to their net pay is only £9,480.

These are example figures only, and your client’s personal tax circumstances and available annual allowance will need to be considered carefully as some restrictions may apply. The above example is not appropriate for a Scottish taxpayer

  • Member contributions are restricted to 100% of relevant UK earnings, and
  • The annual allowance restrictions still apply, although your client’s available annual allowance may be increased by the carry forward of unused annual allowance from previous tax years.

Greater savings may be available if your client pays tax at the additional higher tax rate of 45%.

  • Although, as this is likely to involve pension contributions of £50,000 or more, they may come up against annual allowance tax charges. However, as above, these charges may be avoided or reduced by the use of carry forward of unused annual allowance from earlier tax years.
  • Care also needs to be taken in respect of the tapered annual allowance. Where “threshold income” exceeds £110,000, and “adjusted income” exceeds £150,000, a client’s annual allowance is reduced by £1 for every £2 that their adjusted income is in excess of £150,000 (subject to a minimum annual allowance of £10,000). However, it may be possible to make a substantial personal contribution (carry forward permitting) to reduce your threshold income to £110,000 or lower, which would then restore their 2018/19 annual allowance to the full £40,000. 
  • If your client’s total pension savings exceed their available annual allowance, the annual allowance tax charge will offset the benefit of any tax relief on the excess pension contributions . . . although they may still be able to gain from a restored personal allowance.

Next steps


  • Do you have any clients who are likely to have adjusted net incomes between £100,000 and £123,700 (for the 2018/2019 tax year)?

    These individuals may wish to increase their pension contributions to benefit from:

    - a restored personal allowance,
    - tax relief on their contributions, and
    - increased pension savings for their retirement.
  • Do you have any employers who may be interested in providing a salary exchange arrangement for their employees?
    The ability to restore their personal allowance may be an important consideration for employees when deciding whether to sign-up.

Learning outcomes and reflective questions for CII accredited CPD


Learning objectives:

  • To understand how making a pension contribution can reduce your adjusted net income, potentially helping to reinstate your personal allowance.
  • To be aware of what constitutes your adjusted net income.

Reflective questions:

  • Whether the additional NIC benefits of salary sacrifice make it worth using this option rather than simply making a personal contribution to reduce your adjusted net income?  

Important information


This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2018. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice. (Ref 1.14)

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