Understanding how to effectively use your pension’s annual allowance, especially in a tax year without earnings, can significantly impact your retirement savings.
With changes in the annual allowance from £40,000 to £60,000 in 2023/24, it’s crucial to grasp the importance of pension contributions and the benefits they offer.
(Read Time: Approx. 3 minutes)
Topics Discussed:
- Utilising pension annual allowances in tax years with insufficient earnings.
- Strategies for maximising pension contributions and tax reliefs.
The Challenge of Insufficient Earnings
Many individuals know about the annual allowance for pension contributions, which was £40,000 up to 2022/23 and increased to £60,000 from 2023/24 onwards.
This allowance permits individuals to contribute up to the specified amount into their pension with full tax relief, provided they have sufficient relevant UK earnings.
For example, contributing £60,000 typically involves paying £48,000, with the government topping up the remaining £12,000 as basic rate tax relief.
Higher and additional rate tax relief is then claimed via self-assessment tax returns.
However, the condition of having relevant UK earnings often limits contributions. Relevant earnings include income from employment, self-employment, and (until April 2025) furnished holiday lettings.
This issue can particularly impact sole traders and individuals without employer contributions.
Navigating Pension Rules with Insufficient Earnings
Regardless of your earnings, all individuals are entitled to a ‘basic amount’ of £3,600 on which pension tax relief can be obtained.
Although this only represents a fraction of the maximum allowance, pension rules offer additional flexibility.
One key advantage is the ability to carry forward unused annual allowances from up to three previous tax years, provided you have sufficient relevant UK earnings in the year of contribution.
Notably, the carry forward allowance isn’t restricted by the relevant UK earnings of the earlier tax years.
Practical Example:
Consider Billy, a consultant in the advertising industry, with varying income levels over different tax years:
| Tax Year | Sole-Trade Income | Dividend Income | Total Income |
|---|---|---|---|
| 2021/22 | £0 | £100,000 | £100,000 |
| 2022/23 | £10,000 | £100,000 | £110,000 |
| 2023/24 | £40,000 | £100,000 | £140,000 |
| 2024/25 | £200,000 | £100,000 | £300,000 |
Billy didn’t make any contributions in the first three years as his business was new and growing.
Consequently, by 2024/25, he can carry forward allowances of £140,000 and add a potential current year allowance of £60,000, totalling £200,000.
Given his £200,000 relevant UK earnings in 2024/25, he can fully utilise his brought-forward allowances, despite having only £50,000 of relevant earnings in earlier years.
Considerations for High Earners
For high earners, annual allowances can be further impacted by tapering rules.
Individuals with a “threshold income” over £200,000 and “adjusted income” over £260,000 have their annual allowance tapered by £1 for every £2 exceeded, but not below £10,000.
In Billy’s case, with a threshold and adjusted income of £300,000 in 2024/25, his annual allowance would typically taper to £10,000.
However, by making a significant pension contribution of £200,000 (contributing £160,000 and receiving £40,000 in tax relief), his threshold income reduces to £100,000, avoiding the tapering effect.
Summary
Understanding and navigating the annual allowance rules for pensions can significantly enhance your retirement savings, even in years with no or low earnings.
Strategies like carrying forward allowances and making large contributions can maximise benefits and avoid penalties.
For personalised advice and strategic planning, get in touch with us here at Tax Expert.
Our team of professionals is ready to help you make the most of your pension contributions while staying within tax regulations.
Contact us today at 01772 788200 to find out more about how we can help, or WhatsApp us out-of-hours at 07787 010190.
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Kind regards,
Ilyas Patel