Tax relief on pension contributions - the position after April 2023

In the March 2023 Budget delivered by the Chancellor of the Exchequer there were some important changes to tax on pensions. These tax changes on pension benefits took effect from 6 April 2023.

Tax relief on pension contributions changed in April 2023 and the areas affected are the Lifetime Allowance (LTA), the Annual Allowance (AA) and the Money Purchase Annual Allowance (MPAA).

In this blog, well cover the main pension changes from April 2023 and some tax planning tips around them.

How does pension tax relief work?

When you pay into a pension, some of the tax that would normally go to the government goes towards your pension instead. This can help reduce the amount of tax you pay and be used to help boost your pension savings for the future. This in effect tops up up your pension savings and makes putting money into a pension very tax efficient. The tax relief that is given by the government is based on the rate of income tax that you pay.

You’ll either get the tax relief automatically, or you’ll have to claim it yourself. It depends on the type of pension scheme you’re in, and the rate of income tax you pay.

What type of pensions get tax relief?

There are two kinds of pension schemes where you get relief automatically. These are:

• Your employer takes workplace pension contributions out of your pay before deducting Income Tax
• Your pension provider claims tax relief from the government at the basic 20% rate and adds it to your pension pot (‘relief at source’)

If your rate of Income Tax in Scotland is 19%, your pension provider will claim tax relief for you at a rate of 20%. You do not need to pay the difference.

UK tax relief is also available on contributions made to certain types of overseas pension schemes.

Relief at source

You get relief at source in all personal and stakeholder pensions, and some workplace pensions.

Pension tax changes from April 2023

The Annual Allowance (AA)

The Annual Allowance (AA) is the amount an individual, their employer or any third party can pay into any person’s pension plans each tax year has been increased from £40,000 per tax year to £60,000 per tax year from the 2023-24 tax year onwards.

The threshold at which the Annual Allowance is restricted for high-income individuals is also increasing from £240,000 to £260,000 and the minimum amount after taper is to be increased. From 6 April an individual will see their Annual Allowance reduced by £1 for every £2 their ‘adjusted income’ exceeds £260,000, to a minimum of £10,000 (up from the current £4,000). Adjusted income includes employer pension contributions, salary, pension receipts, interest, dividends and most other sources of income.

Carry forward unused Annual Allowances

Individuals can carry forward unused Annual Allowances from the previous three years to make larger payments if required. However, where this is done the smaller historical annual allowance rates and tapering thresholds will still need to be applied.

The Lifetime Allowance (LTA)

There’s a limit on the total value of pension benefits you can build up throughout your lifetime (this includes private and employer pension schemes). This limit is known as the Lifetime Allowance and is currently £1,073,100. From April 2024 the government plan to completely abolish the Lifetime Allowance allowing people to contribute as much as they want to a pension scheme.

Under the old rules, if your pension value grew to beyond the standard Lifetime Allowance it would trigger a tax charge. But since 6 April 2023, the Lifetime Allowance charge has been removed.

Previously a 55% tax charge applied where amounts above this threshold were withdrawn as a lump sum, or 25% if paid as a pension. There were a number of historical protective elections that preserved the older higher limits provided no further funds were added and these may now need to be reviewed.

If you havent exceeded the Lifetime Allowance and you start drawing down from your pension, you can choose to receive a tax-free lump sum payment of up to 25% of the pension fund’s capital value.

Going forward, although the Lifetime Allowance itself will be abolished, the maximum for this tax-free lump sum will be set at the current level of £268,275 (25% of £1,073,100). This will be relevant if your pension funds exceed the previous lifetime limit as it will limit the amount you can receive as a lump sum tax-free.

If you have a protected right to take a higher amount due to historical elections, you will continue be able to do so. From 6 April 2023 amounts paid out as a lump sum in excess of the tax-free amount will be taxed at your marginal rate, not the 55% rate that previously applied.

Money Purchase Annual Allowance (MPAA)

As explained above, everyone currently has an annual allowance that restricts how much individuals can pay into pensions each year. Once you’ve started to draw your pension, this annual allowance is replaced by the MPAA. It was created to stop people from trying to avoid tax on current earnings or gain tax relief twice, by withdrawing pension savings and then paying them straight back in again.

The MPAA increased from £4,000 to £10,000 from 6 April 2023.

Pension commencement lump sum

A pension commencement lump sum refers to a lump sum that is withdrawn tax-free, once you crystallise your pension funds. It is paid after you have reached a normal minimum pension age, which is currently 55.

As of 6th April 2023, you’ll be able to take 25% of your pension as a tax-free lump sum on the first £1,073,100.

Many people withdraw a 25% tax-free lump sum from their pension pots and take the remaining 75% of pension savings as a flexi-access drawdown or as an annuity.

How do I claim pension tax relief?

Claiming tax relief yourself

In some cases, you need to claim tax relief on pension contributions yourself. You’ll need to make a claim if:

• You pay Income Tax at a rate above 20% and your pension provider claims the first 20% for you (relief at source)
• Your pension scheme is not set up for automatic tax relief
• Someone else pays into your pension

If you’re paying in an amount greater than £10,000, you’ll need to contact HMRC to claim the tax relief.

If you pay Income Tax above 20% (England, Wales or Northern Ireland)

You can claim additional tax relief on your Self Assessment tax return for money you put into a private pension of:

• 20% up to the amount of any income you have paid 40% tax on
• 25% up to the amount of any income you have paid 45% tax on

You can also call or write to HMRC to claim if you pay Income Tax at 40%.

Pension tax relief for low earners and if you dont pay tax

If you are a low earner and do not pay tax, you still get a 20% top up into your pension pot if you are in a relief at source scheme.

Company owners and directors that pay themselves only minimum wage and top up with dividends will not earn tax relief on pension contributions as they will save corporation tax on the amount they put into a pension scheme.

If your employer offers you a salary sacrifice arrangement, you will lose the 20% top up into your pension pot, and you cannot claim any money back from HMRC.

You still need to contribute at least the same minimum amount that taxpayers have to contribute into their pension pots.

How do I know which type of tax relief method my scheme is using?

If youre not sure on the pension tax relief method your scheme or employer are using, it may be simple to ask your HR department or check your pension provider or look in pension scheme booklet if you have it.

You need to check if your provider is using the net pay method where your full pension contribution is taken from pre-tax pay, or the relief at source method where a lower pension contribution is taken from after-tax pay and tax relief claimed from government by your pension provider.

Higher rate pension tax relief

If you are a higher rate taxpayer, you’ll be paying 40% tax on all your income over the higher-rate threshold, so can claim an extra 20% on this part of your income if you pay it into your pension. However, you have to actively claim this money via your self-assessment tax return.

Can other people contribute to my pension savings or can I contribute to theirs?

If you’re in a workplace pension that uses the net pay method, it is unlikely that this will be possible.

If you have a personal pension or SIPP in place that you’ve set up yourself, then someone else could pay contributions or a lump sum into it (if the pension provider allows this). In this case, the contribution is treated as if you made it and the pension provider will claim and add the tax relief to your pension pot.

State pension

From 6 April 2023 the State Pension has increased in line with September’s inflation rate of 10.1%. This is the biggest ever increase to the State Pension. The rise means that those qualifying for a full new State Pension will now receive £203.85 a week (up from £185.15). And those who reached State Pension age before April 2016, who are on the older basic State Pension, will now receive £156.20 – up from £141.85.

You can check your own State Pension forecast on the government’s website.

Pension tax planning tips

Employer Pension Contributions are extremely tax-efficient and can be an essential part of the reward strategy for directors and key employees. The company can make employer pension contributions on your behalf in order to maximise the AA (including any unused AA brought forward from the previous three tax years).

Lifetime Allowance: The company can claim tax relief on the employer contributions, provided these are not considered excessive, and you do not incur a tax charge if the relevant conditions above are met.

• The total value of your pension savings is subject to a Lifetime Allowance (LTA), currently £1,073,100 for 2022/23.
• There is a tax charge on the value of the pension funds that exceed the LTA once you go in to drawdown.
• However, you may be eligible for Individual Protection 2016, which can potentially elevate your LTA to £1.25m.

Flexible Drawdown: You now have more flexibility with how you can access your pension fund once you turn 55 (i.e. you do not have to buy an annuity).

For example, you can take it all out as a lump sum or spread your drawings over more than one tax year and decide on how much you draw each year.

Tax Free Cash: Once you turn 55, you can take out 25% of your pension fund tax-free (with fund value capped at the LTA for these).

Family pension contributions: You can make personal contributions on behalf of your family, with the contributions going to their respective pension funds.

This can include your children, grandchildren and members of your family who are not working.

Where they have no earnings, you can make yearly contributions of £2,880 for each individual, with the government adding a tax-free credit of 20% on top of the contributions.

IHT: A long-term benefit with building up a pension fund is that the value of the fund is typically not liable for IHT at 40%. The pension funds can be transferred to the beneficiaries free of IHT. You must ensure that you have nominated who inherits your pension fund.

The beneficiaries will be liable to Income Tax if they subsequently draw funds from the pension fund. However, there is no Income Tax charge if you, as the pension fund holder, die before the age of 75.

Summary

There were some significant changes to pensions in April 2023. In order to maximise tax relief and pension contributions, it is wise to seek professional advice. Here at dns accountants, we have an experienced tax team who can advise you on tax relief on pension contributions and other areas of tax planning for retirement. For pensions advice and information call our team on 03300 886 686, or email on enquiry@dnsaccountants.co.uk.

About the author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.