Pensions come with a whole host of rules, allowances and jargon, which can result in a number of queries when looking at your own retirement planning. To help, we’ve put together a list of some of the questions, and subsequent answers, that our experts are asked most frequently about pensions.
You can go to a specific question and answer using the links below.
The way in which Income Tax relief on pension contributions is calculated depends on the type of pension scheme under review and the level of Income Tax you pay.
The two main ways in which tax relief is given on pension contributions are through ‘net pay’ arrangements and the ‘relief at source’ method. Net pay arrangements operate exclusively through certain workplace pensions (usually occupational pension schemes). Contributions paid by you personally are deducted from your salary before Income Tax is calculated, which means that you benefit from full tax relief immediately. The second way is via relief at source, where the pension provider claims 20% (basic-rate tax) from HMRC on your behalf.
If you are a higher-rate taxpayer, higher-rate tax relief is either claimed through your employer’s payroll or via your tax return.
The pension annual allowance is based on the amount you have contributed to every pension scheme you are a member of during a tax year. The way you work out how much of it you have used depends on the type of pension plans you have:
Yes, employer contributions count towards your pension annual allowance. If you are an active member of a defined benefit scheme, any contributions you have to pay personally as a condition of your membership will be included in the pension input amount accrued in the tax year. In other words, these contributions will not count separately towards the annual allowance as they do in the context of a defined contribution scheme.
This all depends on how much money you will need for your retirement. One of the best ways to calculate this is through the use of cashflow modelling. It shows you how much money you could have in the future and how much you need to save now in order to achieve the retirement that you want. You’ll easily be able to identify any potential shortfalls before it’s too late to make any changes.
You can access your pension from the age of 55. A defined contribution scheme can be drawn either in the form of a lump sum, an annuity or drawdown. A defined benefit scheme can only be drawn as an income, although part of the income may be paid at the outset in the form of a tax-free lump sum.
You can take the money from a defined contribution scheme as one lump sum. Usually 25% of the pension fund value is tax-free, with the remaining amount being taxable at your highest marginal rate. Unless your pension provider holds a tax code for you, they will still deduct tax on a PAYE month one basis. This means that the pension provider will assume one twelfth of your personal allowance and one twelfth of each tax band. Any excess tax will need to be reclaimed via your tax return or by completing the appropriate tax reclaim forms.
This is possible provided the tax-free cash recycling rules have not been broken. If the amount of tax-free cash withdrawn, together with other tax free sums received over the last 12 months, is under £7,500, the recycling rules will not be triggered. Up to a maximum of £3,600 p.a. or 100% of your relevant earnings can be paid back in. Tax relief will only be available if you have sufficient pension annual allowance remaining. If tax-free cash recycling does apply – where tax-free cash is drawn out and then placed back into a pension to achieve further tax relief – the amount of tax-free cash drawn will be classed as an unauthorised payment and attract heavy tax charges.
Apart from the initial tax-free cash, which usually equates to 25% of the pension value, the remaining amount of your pension is liable to Income Tax at your highest marginal rate. Your pension scheme provider will deduct any tax due using the PAYE system before paying out any income.
If you are not able to give your pension provider a statement of Income Tax for the tax year, such as a P45, you will be provided with an emergency tax code. Income Tax is deducted on a month one basis, which assumes that the same income will be drawn every month for the entire tax year. This means that only one twelfth of the personal allowance, basic-rate band and higher-rate band will be available for each payment. So, if a one-off payment is made via income drawdown, you will more than likely have to pay more tax than necessary and it will need to be reclaimed via your tax return or by completing the appropriate reclaim form.
It is generally best to accumulate a pension via a company scheme as you will benefit from employer contributions which may not be available if you opt out and make contributions into another personal pension. The minimum an employer needs to contribute in to an employee’s pension scheme is 3% of their salary between the lower and upper limit. Many employers offer more than this as an employment benefit.
Your employer may offer you the opportunity to make additional contributions via salary sacrifice. This has the added benefit of reducing your National Insurance cost and your employer may add the amount of employer National Insurance saved to the contribution.
Yes – if you are 55 or older, there is nothing to stop you from continuing to work while drawing pension benefits. If you want to continue to make pension contributions, you may be restricted to the money purchase annual allowance of £4,000.
Trivial commutation is when a member of a defined benefit pension scheme exchanges all of their pension benefits and draws them out as a lump sum, provided the value of all their pensions (including pensions in payment) is less than £30,000. 25% of the lump sum will be tax-free and the balance will be taxed at your marginal rate. You must have reached the normal minimum retirement age (55) and have received the triviality lump sum within three months of the ‘nominated date’. Triviality payments can also be made on death.
If you have a pension which is worth less than £10,000, it can be drawn out as a lump sum. This will not use up any of your pension lifetime allowance nor will it trigger the money purchase annual allowance. Up to 25% of the lump sum is tax-free with the remaining amount taxable at your highest marginal rate. A maximum of three personal pensions and an unlimited amount of occupational pensions can be taken in this way.
Generally, pensions are tested against the lifetime allowance when benefits are drawn, the member dies or reaches the age of 75.
This depends on your individual circumstances and what alternatives your employer offers. For example, if your employer does not offer a higher salary in lieu of pension contributions, then remaining in the scheme may be more beneficial despite the lifetime allowance tax charge being applied.
Assuming that your employer does offer an additional income instead of pension contributions but you are an additional-rate taxpayer, you may discover that you are no worse off directing this increased salary into your pension. If you received extra salary in lieu of your employer’s contributions, your salary would attract an effective tax rate of 47% (i.e. 45% Income Tax plus the additional employee National Insurance of 2%).
It depends on what type of pension you are passing on. If you have a defined contribution scheme, the benefits can be passed over on your death to whoever you choose. You need to complete an ‘expression of wishes’ document naming your beneficiaries, but the pension trustees will make the final decision over who receives the money. Depending on the rules of the pension scheme, the pension can be inherited by way of an annuity, drawdown or a lump sum.
Defined benefit schemes operate differently. The death benefits from these schemes can only be paid to a spouse or civil partner, or to a dependent child up to the age of 23 (unless they are dependent because of a disability).
Generally, most pensions will fall outside of your estate for Inheritance Tax purposes. But there are certain circumstances in which a pension could become liable to Inheritance Tax:
Yes, but only if you are receiving an income via flexi-access drawdown. Even after the pension has been crystallised, it can be passed on free of Inheritance Tax, but capital protected annuities and any unpaid guaranteed income will form part of your estate.
No, the pension will be tested against the lifetime allowance on your death, so an inherited pension will not use up the beneficiary’s lifetime allowance. Only pensions which a beneficiary has accumulated in their own right count towards their own pension lifetime allowance.
If you have any further questions about your pension or would like to speak to someone about any of the matters raised here, contact Tilney now. You can either book an initial consultation online or call us on 020 7189 2400.
Issued by Tilney Financial Planning Limited.
Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change. This article is solely for information purposes and is not intended to be, and should not be construed as financial advice. If you are in doubt as to a course of action you should contact a professional adviser.