How to make the most of your tax breaks

pension-saver-running-away-from-tax-monster

As we approach the end of the tax year, many pension savers will be thinking about ensuring they make full use of the tax breaks available to them.

There have been few clues so far as to what will be in the Budget on 8 March, but the risk of changes to pension tax relief is always on the table, and it's fair to assume any changes are unlikely to make the system more generous.

Working out how much you can put into a pension in 2016/17 is far from straightforward, however. You may need to do a lot of digging before you are able to work out your individual contribution limit for this tax year.

One added complexity in 2016/17 is the reduction in the annual allowance for high earners. The rules are complex, but the gist of them is that anyone with taxable income - including the value of any pension contribution from their employer - in excess of £150,000 will face a reduction in the annual limit on their pension contributions.

CARRY FORWARD IF YOU CAN

The regular annual allowance of £40,000 in tax-relieved contributions each year is reduced by 50p for every pound of income earned above £150,000.

This means someone with an income of £160,000 has their annual allowance reduced to £35,000 - a cut of £5,000. For those with an income of £210,000 or more, there is a floor of £10,000.

Whatever your annual allowance for 2016/17, you may still be able to put more than that sum into a pension by carrying forward unused annual allowances from up to three previous tax years.

This entitlement is particularly relevant this year, because three years ago (in 2013/14) the annual allowance stood at £50,000, so many people may have unused allowances from three years ago that they could use to top up their 2016/17 allowance.

The entitlement to carry forward tax-free allowances from 2013/14 is about to expire, so pension savers should make full use of it.

Unsurprisingly, many people don't know how much unused annual allowance they have, particularly from more distant years. However, you can work this figure out using HMRC's online calculator.

When it comes to money you contributed to defined contribution pension schemes, the rules are relatively simple. The amount that you used up of your £50,000 annual allowance is simply the cash amount of the contribution in that year.

DEFINED BENEFIT SCHEMES

But for defined benefit schemes, it is much more challenging. Essentially, the figure you need is the growth in your annual defined benefit pension rights, adjusted to strip out the impact of inflation and then multiplied by 16.

But the task is much more challenging with defined benefit schemes. The figure you need is the growth in your annual defined benefit pension rights adjusted to strip out the impact of inflation and multiplied by 16.

Understandably, few pension scheme members will know what this figure is or how to work it out.

If you are one of the many who don't, contact the administrator of each defined benefit pension scheme of which you are a member as a matter of urgency, to find out how much of the annual allowance was used up by your accruals in each scheme in each of the tax years 2013/14, 2014/15 and 2015/16.

Once you have added up all your pension inputs from defined contribution and defined benefit schemes for those years, deduct these from the £50,000 annual allowance for 2013/14.

Any remaining headroom can then be added to your annual allowance for 2016/17, but only if you act before 5 April.

A similar process can be applied to carry forward unused allowances from 2014/15. Remember though that the allowance in that year was just £40,000.

You can also carry forward unused allowances for 2015/16, but things get messy. The July 2015 Budget changed the process for calculating annual allowances and divided the year into pre-8 July and post-8 July periods.

It's worth consulting an expert for help working out your scope for carrying forward unused allowances from the 2015/16 tax year.

There is no particular reason to think the chancellor will abolish or restrict the entitlement to carry forward unused allowances in this way in his March Budget. But when a chancellor is short of cash, you never know what he might do.

At the very least, I would encourage everyone able to contribute more to their pension than their basic 2016/17 annual allowance to find out what unused allowances they have from earlier years, so that they can make an informed decision before 5 April.

Steve Webb is director of policy at Royal London.


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