The start of the new tax year brought about an increase in the minimum contributions that need to be made to your workplace pension scheme, and with it a potential tax trap for high earners and/or more generous employers.
The Tax Trap
From the 6th April 2019 the total minimum contribution that needs to be made to your workplace pension is 8% of qualifying earnings (£6,136 to £50,000). This is made up of a minimum contribution from the employer of 3% (previously 2%) and 5% from you (previously 3%).
Whilst it’s good news that more money is going into your pension (they are a fantastic tax efficient saving tool after all), there can be a nasty tax trap for those earning over £150,000.
At this level of earnings your £40,000 pension Annual Allowance (the amount that can be paid into a pension) starts to reduce by £1 for every £2 you are over, until you are left with an allowance of just £10,000 per annum. This is called the Tapered Annual Allowance.
I have come across a number of clients whose employer is paying them much greater pension contributions based on full pay. Without realising it you could be contributing more than your reduced Annual Allowance. This will result in a nasty tax bill.
You may already be on the case regarding you reduced Annual Allowance and have adjusted your contributions into your own personal pension accordingly. However has your company auto enrolled you into the company pension scheme and have you included these new contributions into your overall allowance?
Also, if you have accessed a pension in the last few years you may find your Annual Allowance is reduced again down to £4,000, called the Money Purchase Annual Allowance.
How to avoid the pension tax trap
As always you need to get informed. Pension taxation is a minefield and there are exams for Financial Advisers on pension taxation alone!
Here are a few steps to take:
#1 – Check with your company
Check the contribution levels being made into your company pension scheme. Speak to your HR/Payroll team. Add both employee and employer contributions to any contributions you are making to any separate personal pensions.
#2 – Seek financial advice
As mentioned the rules are complex. If you are earning over £150,000 then you need to calculate what your Annual Allowance is. How much do you lose?
Even if you do face the nasty tax trap it may still be better to take the additional pension contributions and pay the tax, especially if your company is paying more generous employer contributions and/or willing to match what you put in.
BUT there is the pension Lifetime Allowance to consider. Again this all needs professional analysis.
#3 – Ask your employer for alternative remuneration
If the pension contributions paid by your employer does mean you fall into the tax trap, ask if they will consider swapping the additional pension contributions for additional pay. You could then invest into alternative tax efficient investment products without the restricted allowances.
If you are concerned about your pension position and how much tax you may pay as a result of the tax trap, why not get in touch. We would be happy to guide you through the minefield.
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