It is impossible to escape the new pension rules that declare: from April 2015, if you are aged 55 or over, you can withdraw the whole of your pension pot. What’s more, 25% of which can be taken tax free. The generosity of this announcement has prompted many people to begin contributing more money in to their pension fund, either by increasing their monthly contributions or by paying in a bulk sum, primarily as a result of a bonus. Whilst this is good practice, it is important that if you want to make increased contributions you do not get carried away and exceed your annual allowance.
The annual allowance – the amount you can contribute tax free each year to a pension – fluctuates. This tax year (2014 to 15) the annual allowance is £40,000. Therefore, an ‘annual allowance charge’ will be triggered by payments that exceed this amount. It is important that this criterion is not forgotten and that contributions are tracked to ensure that, whilst the pension relief is being taken advantage of, payments are not exceeding the annual threshold. However, as long as you are aware of the annual allowance, if you do wish to pay a lump sum into your fund there are still ways to do this tax efficiently. Most people wish to make a significant one of payment as a result of a bonus. The one main advantage of this is that PAYE and NI, which is always deducted from bonuses made by a business to an employee, can be saved. Through requesting for a bonus to be paid directly into a pension scheme, instead of directly to you, no PAYE or NI will be deducted. Therefore, the full bonus will be added to your pension fund. If the bonus is below the £40,000 threshold, this is a great way to save tax. However, if the amount does exceed the limit, there are still things you can do to protect your money. Every pension scheme has a Pension Input Period (PIP), which, on average, runs for a year.
This is the period where you are able to review your total pension savings to ensure they do not exceed the annual allowance. Therefore, if you were to have two pension schemes you would have two separate PIP periods. If you were then to extend one of your PIPs into the next tax year, you can essentially take advantage of two years’ worth of allowances. This means that if your bonus exceeds £40,000, you can split the payment into two separate pension schemes, getting tax relief on the whole of your bonus. The changes to the pension rules have incentivised people to contribute more to their pension funds. To take full advantage, it is just important that your are aware of the advantages as well as the limitations.