Pension allowance tax traps?

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Increasing numbers of people are facing substantial tax penalties on their pensions, sometimes unexpectedly. Are you at risk of an unwelcome surprise?

The tax and national insurance contribution reliefs enjoyed by pensions cost the government £53.7bn in 2017/18, according to statistics issued by HMRC in September 2019. It is little wonder therefore that successive Chancellors have attempted to cut back on such levels of generosity.

The most recent attacks on pension reliefs have focused on two key allowances:

Personal tax relief is effectively clawed back on excess contributions over the available allowance (which can include unused allowance from the preceding three tax years). About one third of the tax payments due is collected as a deduction from the individual’s pension fund, but most is reported and collected via self assessment. There is no special tax treatment for the benefits arising from these contributions, so you could receive no contribution tax relief, but still pay income tax on your eventual pension.

Complex calculations

The penal tax charges for breaching the lifetime or annual allowances were probably designed to be more of a deterrent than a revenue raiser for the Treasury. In practice, the charges have proved to be money-spinners for the government. As the graph shows, in 2017/18 over 26,500 people reported contributions exceeding their available allowance, nearly five times the number two years previously. The lifetime allowance charge raised £185m in 2017/18, virtually double what it did two years before.

One reason why these hefty charges are being paid is the complexity of the calculations involved. For example, the amount of the tapered annual allowance cannot be accurately calculated until after the end of the tax year to which it relates.

If you may be affected by either, or both, of these pension tax charges, then it is vital to take advice as soon as possible. Ultimately, you may need to consider some additional alternatives to pensions for your retirement planning.

The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

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