This year it could be possible for some individuals to pay as much as £240,000 without having any annual allowance tax charge.
Once the 5 April deadline has passed the amount that can be contributed will also start to wane, and will continue to do so for the next four years.
It makes sense to start planning now so that the scope for a payment can be established and the source of funding decided, all in good time.
Someone who has not contributed since the financial crisis in 2008 may be able to pay up to £200,000 today, depending on other factors such as earnings. But if they delay it until next year it would fall to £190,000.
Why? Because the current £50,000 annual allowance will be cut to £40,000 from the next tax year. This will leave £40,000 from that year plus £50,000 for each of the three carry forward years.
And the amount will reduce by £10,000 for each further year funding is put off until 2017/2018 is reached when the maximum will have dropped to £160,000.
But if payments can be made for pension input periods ending in the current tax year, the maximum available annual allowance is £200,000 – comprising four lots of annual allowance at £50,000 per year.
It is potentially possible to pay more than £200,000 in the current tax year. To achieve this involves closing pension input periods early and making payments to a new pension input period ending in the next tax year.
For example: Jim is a director of his own company and has a Sipp but has made no contributions since 2008. The pension input period for this contract ends on 31 December each year.
He can make a payment through his company of £200,000 before 31 December 2013. This will use up the annual allowance for 2013/2014, plus the unused allowance for the past three tax years.
But he could pay an additional £40,000 by closing the current pension input period early and paying towards the new pension input period which ends in 2014/2015. So the total payment he can make now is £240,000.
What about pension input periods already ending in 2014/2015? To ensure that any unused allowance from 2010/2011 is not lost it is possible to start a new arrangement. By default the pension input period for this new contract would be 5 April 2014 and so ends in the 2013/2014 tax year, giving immediate access to any unused allowance from 2010/2011.
Reverting to the earlier example: What if Jim’s pension input period ended on 30 April each year? Any payments now made to his pension would already be to a pension input period ending in 2014/2015.
On the face of it Jim has lost his unused annual allowance from 2010/2011. The maximum he could pay in today with no further action is £190,000 – that is the £40,000 annual allowance for 2014/2015, plus three lots of £50,000 unused allowance going back to 2011/2012.
But Jim can still benefit from the 2010/2011 unused allowance by taking out a new pension arrangement. The pension input period for this new contract would end on 5 April 2014, allowing him to go back and pick up the £50,000 allowance from 2010/2011, so total payments will be back up to £240,000.
Keeping payments within the annual allowance avoids a tax charge but it is not a green light for tax relief on the contribution.
Individuals will only get tax relief on payments up to 100 per cent of their earnings. This means that if someone has unused annual allowances of £100,000, they must also have earnings of at least this amount in the current tax year to get full tax relief.
Where the employer is making the payment to an employee’s pension, then the company must be confident that the payment is allowable as a deduction from profits before corporation tax. It does not matter that it can cover the payment from the cash account – a common misconception. ‘Cash’ is not a profit and loss item.
The lifetime allowance should also be considered. This will drop to £1.25m from April 2014. Benefits taken above this value will suffer the lifetime allowance tax charge – 55 per cent if the excess is taken as a lump-sum. This may act as a moderator on the amount of current funding undertaken and could open the door for conversations around alternative ways of saving.
There is a window of opportunity to make larger tax-efficient contributions this year while the annual allowance is still £50,000. Although the opportunity will remain in future years, it will be at diminishing levels – the case made for ‘use it or lose it’.
Dave Downie is technical manager of Standard Life
Key points
The annual allowance cut from £50,000 to £40,000 for tax year 2014/2015 opens the door to pension funding for the current tax year.
Once the 5 April deadline has passed the amount that can be contributed will also start to wane, and will continue to do so for the next four years.
There is a window of opportunity to make larger tax-efficient contributions this year while the annual allowance is still £50,000.
