‘Carry forward’ method could help ‘reduce tax bill’ in retirement

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As the end of the tax year fast approaches, savers and investors should consider whether they are using their allowances to maximum effect. Amid frozen thresholds and increasingly higher tax burdens, maximising pension contributions now could be a good step to prepare for the future, and one option could be to utilise the “carry forward” pension allowance, an expert has said.

Gary Smith, director of financial planning at Evelyn Partners, said: “With the personal income allowance and thresholds frozen until 2028, many taxpayers will be quite sensibly looking towards pension saving in order to mitigate against income tax (and National Insurance) liability that is creeping ever-higher as nominal earnings increase across the economy.”

Mr Smith continued: “The ability to carry forward your pension allowances provides a great opportunity to reduce your tax bill and save for retirement. And this might be particularly opportune this year as Chancellor Jeremy Hunt has made it clear that he is prepared to make some hard decisions in order to stabilise the public finances.”

The carry forward allows people to make use of any annual allowance they may not have used during the past three tax years, provided that they were a member of a registered pension scheme at the time.

The annual pension allowance is the maximum amount a person can pay into their pension in a year to benefit from tax relief. Currently, for most people, this stands at £40,000. If any more is paid in during the tax year, an extra charge is applied.

However, Mr Smith warned that there are some rules to note for anyone thinking about carrying forward.

Firstly, he said: “You must have used up the current year’s allowance. The first step is to get an accurate reading of this year’s contributions and take those to the limit.”

To get tax relief on pension contributions that the person has made themselves, they also need to ensure that the payments made in any tax year do not exceed earnings in that year.

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Mr Smith elaborated: “An employer is not restricted by an individual’s earnings so they are able to pay in higher sums on occasion.”

People will also need to have had a pension in each of the three previous tax years, however, Mr Smith noted: “You don’t need to have made any contributions and your new contributions do not have to be made into the same pension.”

Finally, Mr Smith said: “Allowances from the ‘oldest year’ are used up first and at the end of every tax year, the oldest year falls away. Therefore, any allowances not used from the oldest year – now 2019/20 – will be lost for good if they are not carried forward, so it is worth checking one’s contribution history to see where there is the most unused allowance.”

Those whose financial position has improved and who want to take advantage of the tax reliefs on offer are one of many groups who can largely benefit from this option. For instance, those who have received a lump sum or their earnings are higher than in previous years.

Mr Smith said: “Anyone over 50 years who receives a lump sum that they do not immediately need might consider ploughing it into their pension via carry forward as it will not be long before they can access a chunk of those savings tax-free anyway under pension freedom rules.”

It can also be particularly useful for high earners whose current year pension contributions are now restricted by the tapered allowance because they have a total income of over £240,000.

Mr Smith said: “For anyone in this position, which can see their current year allowance drop to as low as £4,000 if they are in receipt of £312,000 or more, then the opportunity to mop up unused allowances from the previous year is one that should be seriously considered, especially if their earnings in those years were below the threshold for the tapered allowance.”

Carry forward also has further benefits beyond retirement planning as maximising a pension can potentially remove funds from a person’s estate for inheritance tax purposes and gives options to pass on wealth to their heirs in a more tax-efficient way.

However, Mr Smith noted: “There are also potential pitfalls. With the pension lifetime allowance now set at £1,073,100 for the next few years, care needs to be taken to ensure that contributions and growth in your investments won’t take you over this limit, as you will be liable for a tax charge on the excess when benefits are taken.”

As per Mr Hunt’s new income tax rules announced during November’s Autumn Statement, those earning between £125,140 and £150,000 will be paying the additional income tax rate of 45 percent from April 6.

However, Mr Smith said: “This will translate into a greater tax relief boost on pension contributions, which might complicate decisions over carry forward. Questions around tax relief and carry forward can get very confusing and it’s always best to seek advice from a financial planner in these matters.”

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