The carry forward rules were introduced in 2011 and are not to be confused with the ‘carry back’ facility that was available in previous years. Carry forward allows you to make higher contributions to your pension without incurring tax penalties, although this is subject to several conditions.
Why Should You Contribute to a Pension?
First of all, it is worth understanding why you should contribute to a pension in the first place. As well as allowing you to build up a pot for your retirement, there are multiple tax benefits:
- Contributions receive tax relief of 20%. This can take your personal contribution of £80 up to £100 without costing you extra.
- Higher and additional rate taxpayers can claim further relief as part of their tax return.
- Pension contributions can help to bring your earnings under certain thresholds to reduce the amount of tax you pay.
- Contributions deducted from your salary can also reduce your National Insurance contributions.
- Employer contributions are usually an allowable business expense, even for company directors.
- Your pension fund grows free of income and capital gains tax.
- When you retire, you can take up to 25% of your pot as a lump sum. The remaining fund is taxable when you withdraw it, but the income options are highly flexible.
What Are the Contribution Limits?
There are several limitations on your pension contributions, which can be confusing as some of the rules appear to contradict each other. Put simply:
- Theoretically, anyone can contribute as much as they like to a pension. The limitations really concern whether you will receive tax relief or incur penalties. You also need to bear in mind the limitations set by your pension provider.
- Tax relievable pension contributions can be made from childhood up to age 75 providing you are a UK taxpayer.
- Anyone eligible can make a net contribution of up to £2,880 per year (which will be grossed up to £3,600) regardless of employment situation.
- If you have relevant earnings, for example, from employment or trading profits, you can make a gross personal contribution up to the level of your income. Dividends, interest, and property rental do not count towards relevant earnings.
- Employer contributions are not limited by earnings, but must be deemed reasonable by the local inspector of taxes.
- Personal and employer contributions are subject to the annual allowance of £40,000 per year.
- Anyone earning over £240,000 has their annual allowance reduced by £1 for every £2 over the threshold. This means that the annual allowance may be as low as £4,000 for anyone earning over £312,000.
- If you have taken taxable benefits from a flexible pension, you will also have a reduced annual allowance of £4,000 per year. This is known as the Money Purchase Annual Allowance (MPAA). This is intended to avoid the ‘recycling’ of pension contributions and the possibility of claiming tax relief twice.
How Much Can You Carry Forward?
You can carry forward your annual allowance by up to three tax years. This means that in theory, you could contribute up to £160,000, i.e. £40,000 for the current tax year, as well as each of the previous three tax years.
Your contributions are first applied to the current tax year, followed by the previous tax years, with the earliest being used up first.
As the three year limit occurs on a rolling basis, you may need to look at your contributions up to six years ago to fully calculate your carry forward allowance, particularly if you have made large contributions in earlier years.
There are a number of conditions and practicalities to consider:
- You can only use carry forward if you have been a member of a pension scheme for all of the tax years in which you are claiming the annual allowance.
- If your annual allowance is reduced due to earnings, you can still use carry forward. However, you will need to calculate the reduced annual allowance for previous tax years depending on your earnings at that time.
- If you have triggered the MPAA, you cannot use carry forward.
Should You Carry Forward Your Annual Allowance?
Carry forward may be a good option for you if:
- You have been a member of a pension scheme for at least 4 years but have not used your full annual allowance.
- You have not taken flexible benefits from your pension.
- You have at least £40,000 to invest either as a lump sum or from surplus income and pensions are your most tax-efficient option.
- You earn over £40,000 per year as an employee.
- Alternatively, you are a company director and want to make large contributions from the business. As turnover can be variable, it might not be practical to use your full annual allowance every year. The carry forward rules give you more flexibility to top up your pension in more profitable years.
Most people have no requirement to pay more than £40,000 per year into a pension, and average contributions are significantly lower than this. However the carry forward rules can provide some additional flexibility if you are a higher earner, business owner, or if you come into a lump sum. If you fall into any of these categories, a financial adviser may be able to help you decide on the best option.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.
