Business

Pension problems - taking a contribution instead of a bonus

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QUESTION: My employer has indicated that I am due a significant bonus before the end of 2021/22 tax year. I am considering taking a pension contribution instead of a bonus but am unsure of the contribution rules and I have been told that I may have a lifetime limit issue?

ANSWER: There are considerable tax & national insurance savings for both you and your employer if you opt to take a pension contribution instead of a bonus payment. The amount that a UK tax payer can contribute to their pension annually is capped at £40,000.

If they have an existing pension scheme and have not made maximum contributions in the three previous years, they can also carry forward any unused contributions and make a very significant contribution in a single tax year.

There are several complications however, currently in the area of pensions. The first of these is that pension contribution levels are restricted for very high earners. Thankfully, the income level at which contribution levels start to be tapered has increased in recent years from £150k to the current level of £240k.

Once your adjusted income exceeds £240k, the annual £40k allowance is reduced by £1 for every £2 that income exceeds this level to a minimum of £4k.

On the assumption that you do not have a contribution limit issue and wish your employer to maximise your contributions using your unused relief, the next problem that you face is the actual size of your pension pot known as the “lifetime allowance”.

The lifetime allowance is the maximum amount that you can hold in your pension pot before incurring a tax charge and it is currently fixed at £1,073,100.

If you save more than this amount, large tax bills will be triggered when you withdraw money from your pension. Lump sum withdrawals incur a 55 per cent penalty. Historically, pension pots were unlimited. But successive governments have tinkered with this allowance, bringing it down to its current level which started at £1m but was increased annually by inflation.

The Chancellor, however, has frozen the limit for five years until 2026 to try and assist in rebuilding public finances and this is going to affect tens of thousands of pension savers who will incur high tax charges given that inflation is currently 5.5 per cent and set to go up to 7.25 per cent by the the summer.

Current predictions estimate that had this allowance not been frozen, in five years’ time it would have risen to £1.37m. Therefore, its freezing affect on a saver is equivalent to a tax charge of over £150k. If you expect to have a lifetime allowance issue, there are some measures that you can take now to protect your position.

If your pension savings exceeded £1m at April 2016, you can apply for one of two protections - namely “Individual Protection 2016” which maintains your lifetime allowance at the lower of either £1.25m or the actual value of your pension pot on April 5 2016 and you can continue to contribute to your pension, but you will have to pay tax on any withdrawals beyond the protected amount.

The other protection is called “Fixed Protection 2016” which fixes the allowance at £1.2m however, prohibits you from paying anything into your pension without incurring a tax charge. The latter protection therefore is typically chosen by people who had large pension pots as at April 5 2016 and to expect them to rise in the future without having to make further contributions.

In summary therefore, you should contact your independent financial advisor without delay to determine firstly your ability to access any unused relief that you may have available and secondly, to assess your lifetime allowance position and whether or not you can and/or should apply for one of the available protections.

:: Paddy Harty (p.harty@pkffpm.com) is a senior tax director at PKF-FPM (www.pkffpm. com). The advice in this column is specific to the facts surrounding the question posed. Neither the Irish News nor contributors accept any liability for any direct or indirect loss arising from any reliance placed on replies.