Tax & Admin

Pension Tax Relief, Limitations, and the Carry Forward Rule

Staff writer | 4 March 2022 | 2 years ago

pensions

Pensions are one of those rare things that everybody in the UK – and most of the world – is eligible to receive. Beyond that fact, there are several things each person needs to be aware of at every stage of their pension journey, from thinking about saving to drawing it out for the first time. Can you make the money work for you? How much will you receive? Can you really live on what the government sees fit to give to you?

Tax brackets

In most of these questions (and their answers), the idea of limitations plays a role. While you can save as much as you like for retirement, there’s no getting away from the fact that, to qualify for government tax relief, you’ll have to restrict yourself to no more than 100% of your annual salary in pension payments, which cannot exceed £40,000/year. Why? Tax relief costs the government a lot of money.

Tax relief on pensions is scaled according to tax brackets, whether that’s basic-rate, higher-rate, or additional rate. This basically means that you’ll either receive 20%, 40%, or 45% back on whatever you pay in. As far as incentives for savings go, it’s not bad – but the downside of the government’s involvement is that you’ll be charged a fee if you exceed your annual allowance.

Advice on claiming tax relief is available in many places online, but it’s important to be aware of how your pension provider handles your contributions. For instance, SIPPs or Self-Invested Personal Pensions are topped up with tax relief when the provider requests the funds directly from the government. This process can take up to three months to complete, however.

SIPPs are largely focused on making investments to improve the amount of money pension receivers have available to them when the time to retire rolls around. There’s an obvious element of risk involved with this kind of product, though, so they require special consideration when deciding what you invest in, whether this is stocks, ETFs, investment trusts and so on.

Carry forward

An obvious question here is, what if you don’t reach your annual allowance? Inevitably, not all of us will be capable of saving $40,000 each and every year. However, if your circumstances improve and you suddenly find yourself with a surplus of funds, you can make contributions in excess of the maximum amount. Several quite stringent rules apply, which may or may not make extra payments undesirable.

This is the Carry Forward rule. Just a few of its stipulations are that you must have been in a pension scheme for all relevant years, have exhausted your allowance for the current year, and be willing to use allowances from the most distant years first. You also need to show that you are earning at least the amount that you wish to add to your pension pot during that calendar year.
It sounds a lot more confusing than it actually is, but, in summary, it just means that unused allowances can be moved to different years. What can’t be carried over is the lifetime allowance, unless you’ve managed to work an agreement out with some cosmic entity. The lifetime allowance as of the 2021/22 tax year is £1,073,000. This works out at less than 35 years of contributions at the maximum rate of £40,000/year.

Pensions aren’t always the most exciting thing in the world, but they provide security in older age, as well as the opportunity to invest in various stocks and funds. Just be aware of your limits and allowances to ensure that you’re not paying tax on your savings where you ought to be claiming that valuable relief.

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