Pension planning for Barristers
Pensions can be seen as complex beasts, but are actually one of the most tax-efficient savings pots available. You can start contributing to a pension from the day you are born and under current legislation you can start to withdraw from age 55 (rising to 57 in 2028).
Currently, you can take 25% of your pension tax-free and the remaining 75% is subject to tax at your marginal tax rate. The following few pages aim to summarise some of the more complex aspects of pension planning and include some worked examples.
All of the rules we discuss are subject to legislative change in the future. Pensions are a bit of a political hot potato and are constantly being tinkered with.
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Tax relief examples
Utilising your available annual pension allowance is one of the most tax-efficient forms of saving for higher and additional rate taxpayers. The standard annual allowance is £40,000 but it can be as low as £4,000 (more on this later).
A higher rate taxpayer would need to contribute a net amount of £32,000 into their pension for it to be ‘grossed’ up to the annual limit of £40,000. The pension scheme will reclaim the basic rate relief from HMRC and add it to the individual’s pension. The remaining £8,000 tax relief comes through a reduction in the tax bill once the self-assessment is completed. A £40,000 gross pension contribution has, therefore, cost the higher rate taxpayer just £24,000, once all tax reliefs are accounted for.
Pension carry forward
Pension carry forward is a useful tool for pension planning. Once an individual has fully utilised their current tax year’s allowance, one can go back and utilise the unused pension allowance from the previous three tax years, starting with the oldest first.
Potentially, this enables one to make quite a large pension contribution in a given year. Care needs to be taken on various issues, especially having sufficient ‘earned income’ for the large pension contribution.
Tapered annual allowance
The tapered annual allowance rules kicked in on 6th April 2016, when those with taxable earnings over £210,000 per annum were limited to pension contributions of £10,000 gross each tax year. This was a controversial piece of legislation and also quite complicated. The rules were altered from 6th April 2020, whereby those earning in excess of £312,000 are now limited to an annual allowance of £4,000. This has made planning for self-employed individuals quite tricky, especially for those that have a tax year end of 31st March each year. Some good news, the carry forward rules still apply to those affected by the taper.
Lifetime Allowance
The Lifetime Allowance (LTA) is an overall limit on the amount an individual can accrue across their pension schemes in their life. The limit has reduced massively over the past decade and has been frozen since 2020-21. The LTA for the 2022/23 is £1,073,100. The LTA tax charge is not levied immediately on reaching the limit, but usually once the individual takes benefits from their pension. Individuals that have built up large pension pots through their 30s and 40s may need to be wary of over funding their pension, to avoid breaching their limit once they reach pension age.
A high rate tax payer (40%) making a pension contribution of £10,000 net (which grosses up to £12,500 once tax relief is received direct from HMRC).A further 20% tax saving is made via your self assessment tax return, with a contribution this size effectively reducing your income tax bill by a further £2,500 (20% of £12,500).