Long Read  

Happy birthday to £3,600 or more

Happy birthday to £3,600 or more
Annie Spratt/Unsplash

The 21st century seems to have been one of constant change in the pensions world.

Stakeholder pensions were introduced in 2001, followed by pension simplification in 2006 and then pension freedoms in 2015. This is not to mention the many other changes, including auto-enrolment, the abolition of contracting out, guaranteed minimum pension, retirement risk warnings, investment pathways and the ever-moving state pensions age. 

Many of these came with attendant changes to the rules and regulations covering pensions taxation. 

While there have been lots of pension tax changes since 2001 – the annual allowance(s) for instance – the actual mechanics of pension tax relief in a ‘relief at source’ scheme, such as personal pensions, has never changed:

  • An amount, net of basic rate tax, is paid.
  • The scheme reclaims that basic-rate tax and adds it to your pension.
  • Your basic and higher tax threshold increase by the grossed-up contributions.
  • You may be able to reclaim higher tax relief through self-assessment.
  • 100 per cent of your relevant earnings is the maximum gross contribution you could pay. 

It has been that way certainly for as long as I can remember.

Back on April 6 2001, some 21 years ago, stakeholder pensions were introduced, which had specific rules around cost charges and access.   

Pension simplification swept away most of the pension tax changes we saw in 2001 so they have not seen their 21st birthday. However, there is one survivor in particular that has lived to reach this milestone and is, I believe, the only actual material change to how pension tax relief works in the 21st century.

There have always been, and there still are, limits on contributions. There were age-related percentages of your earnings you were allowed to contribute, you had carry back and carry forward (the old one not the annual allowance one), and 'basis year rules'.  

Myriad rules and nuances, but one thing was common – you had to have relevant earnings. For the first time, from April 6 2001 you could pay in £3,600 gross regardless of relevant earnings, “… or £3,600 if higher” (according to HM Revenue & Customs).   

This gave non-working partners, those having long career breaks, those unable to work for one reason or another or simply those whose with no relevant earnings, the ability to fund their pensions.

And this gave rise to my favourite pensions-related question: how much can you pay into your child’s pension? And the correct answer is 100 per cent of their relevant earnings or £3,600 if higher. 

It was a good change and one that has and will continue to benefit those looking to make their money work harder for them. 

To illustrate, let us look at three different scenarios where “or £3,600 if higher” has benefited non-earners.

If you have no earnings you can still have £3,600 in a pension and, since 6 April 2008, it only costs you £2,880 (it only cost £2,808 prior to that when the basic rate was 22 per cent). If you access that money when you are a basic rate tax payer you get £3,060 back – £180 gained. The basic principle is that the systematic moving of savings into the pension system, even though you have no relevant earnings, generates extra wealth, making savings last longer or money grow further which can only be a good thing.