Types of schemes
There are two main types of pension schemes:
Occupational schemes are set up by some employers to provide benefits for their employees when they retire.
A Personal Pension scheme is privately funded by you but can also be funded by your employer. An employer may set up a personal pension scheme for their employees through a Group Personal Pension scheme.
A stakeholder scheme is simply a type of personal pension plan where the fees charged by the pension provider are restricted by legislation.
It is important that professional advice is sought before taking out any form of pension.
What are the tax effects of a Pension?
In order to receive tax relief on pension contributions, the pension scheme must be registered with HMRC. This will generally be arranged by the pension provider.
Once registered, as well as permitting tax relief on the contributions, the funds within the scheme can grow tax free. An employer can contributes to the scheme on behalf of an employee, and obtain a deduction from their taxable profits.
There is an annual limit on the combined amounts from employer and employee that can be contributed to your pension; currently £40,000. Amounts in excess of this allowance will trigger a charge.
There is also a lifetime cap on the maximum figure for savings in the pension fund(s) and has to be considered when key events happen such as when a pension is taken for the first time.
There are other restrictions on contributions as set out below.
Key features of Personal Pensions
- The fund is invested for long-term growth until retirement
- At retirement, which may be any time from the age of 55, the accumulated fund is turned into retirement benefits, comprising income and a tax free lump sum,or
- The accumulated fund can remain invested and sums withdrawn via income drawdown
- contributions are paid net of basic rate tax and the provider claims the tax back from HMRC
- Higher rate tax relief is given through the self assessment system
- Employer contributions are paid gross with tax relief given by a reduction in taxable business profits
Who is eligible to contribute to a pension?
All UK residents are entitled to have a Personal Pension, even non-taxpayers such as children and non-earning adults. However, they will only be entitled to tax relief on gross contributions of up to £3,600 per annum.
Relief for individuals’ contributions
An individual can make contributions and receive tax relief on the greater of £3,600 or 100% of earnings in each tax year. Tax relief will generally be restricted for contributions in excess of the annual allowance.
The annual allowance
The annual allowance is currently £40,000 but in order to determine if the allowance has been exceeded a pension input period needs to be determined. An input period does not have to be the same as the tax year.
Any contributions in excess of the annual allowance may be charged to tax on the individual as their top slice of income. Contributions include those made by an employer.
This is to discourage pension saving above the annual allowance.
The rate of charge
The charge is calculated on the excess over the annual allowance at the “appropriate rate” in respect of the total pension savings. There are exemptions from this charge in the case of serious ill health as well as death.
The “appropriate rate” will generally be the individual’s top rate of income tax.
Carry forward of unused annual allowance
To allow for individuals who may have fluctuating pension savings, with large contributions in one year but smaller amounts in other years, a carry forward of unused allowance is permitted.
The carry forward rules allow the current year’s allowance to be increased by the unused annual allowance of the previous three tax years and means that in practice the unused annual allowance of up to £40,000 per year can be carried forward for the next three years.
The lifetime limit
The lifetime limit is the maximum figure for tax-relieved savings in the fund. it is currently £1 million.
If the value of all schemes exceeds this limit when benefits are drawn from the scheme, there will be a tax charge of 55% of the excess, if taken as a lump sum, and 25% if taken as a pension.
How can we help?
This information sheet provides general information on the making of pension provision. Please contact us for more detailed advice if you are interested in making provision for a pension.