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Pensions and high earners

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Summary

Whether you plan to change career, travel the world, follow your passion or do charitable work, good financial planning can help you make the most of the best years of your life.

3 min read

By ignoring pensions, a lot of high earners are missing out on benefits that could mount up significantly in the long term.

While many people will have pension contributions included as a benefit from employment, this isn’t true for everyone. A lot of high earners working in professional services – partners in a law firm, for example – or entrepreneurs running their own business, aren’t currently investing through a pension.

While the tax reliefs offered on pension savings have been reduced by the government in recent years, it’s still one of the most efficient ways to make long-term investments for later in life.

 

Make the most of your pension benefits

Aside from a small number of workplace schemes, most pensions are ‘defined contribution’ schemes. These operate along similar lines to most other investments – you make contributions into a fund which is invested with the aim of adding investment returns to your own contributions.

Unlike a lot of other investments, pension contributions attract tax relief – this is one of the key attractions of saving through a pension scheme. Currently, in the 2018/19 tax year, most people can get tax relief on annual contributions equivalent to their total annual earnings – up to a maximum of £40,000 each year, known as the ‘annual allowance’.

But high earners need to be aware that they may be subject to a lower annual allowance if they earn more than £150,000. Broadly speaking, the annual allowance currently tapers at a rate of £1 for every £2 above the threshold, to a minimum of £10,000.

What level of pension contributions attract tax relief?

Annual Income Reduction in annual allowance due to tapering at £1 for every £2 above limit (currently £150,000) Pension contributions that attract tax relief
£0 £0

£3,600

 

(non-earners are also entitled to tax relief on a limited amount of pension contributions)

£25,000 £0

£25,000

 

(annual allowance is limited to total annual earnings)

£100,000 £0 £40,000
£200,000 £25,000 £15,000
£300,000 £75,000

£10,000

 

(minimum contribution limit for earners)

Even at the minimum tapered annual allowance, you could be entitled to £4,500 of tax relief each year. Given the long-term horizon of pension investing, where you could be making contributions and seeing your investments grow for 20 or 30 years or more, this could represent a substantial addition to your investments.

And in addition to tax relief on contributions, investments in pension funds aren’t subject to income or Capital Gains Tax. This means that they should in theory grow more quickly than other types of investment. 

“While the tax reliefs offered on pension savings have been reduced by the government in recent years, it’s still one of the most efficient ways to make long-term investments for later in life.”

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Lifetime allowance

High earners need to be aware of the lifetime allowance. If the value of your pension benefits exceeds the allowance when you start taking your money out – and in some other circumstances, such as when you turn 75 – then you may be liable to an additional lifetime allowance tax charge.

This has also been sharply reduced by the government over the last decade. It’s currently £1,030,000 for the 2018/19 tax year and will rise each year in line with inflation as measured by the Consumer Prices Index (CPI). This includes not just the contributions you make but also any investment growth.

If you’ve previously contributed to a pension – for example through a workplace scheme from previous employment – you may already be near to, or even in breach of, the current limit. If this is true of your pension pot, then you should speak to your wealth manager or financial adviser to help you think about the right steps for you.

 

What to do with your pension investment

The tax reliefs associated with investing through a pension come at the cost of limitations on how you can use your pension pot:

  • As pensions are intended for later life, you generally can’t take your money out before age 55 (the age limit is expected to rise to 57 in 2028)
  • You can take up to 25% of your pension pot as a tax-free cash lump sum, but further cash withdrawals will be taxed at your marginal rate
  • You can also use some or all of your pension pot to provide an income, either through an annuity or regular withdrawals from your investments, which is taxed at your marginal rate

For many high earners, their pension pot will be just one aspect of how they intend to fund their later life. Income from property, Individual Savings Accounts (ISAs) and other tax-efficient savings will also play their part. Our article Time to Take Your Pension outlines some of the key questions to consider as you reach the age when you start thinking about taking your pension benefits.

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Please note:

The above commentary is based on our understanding of current tax law, which is subject to change in the future. The availability and value of any tax reliefs will depend on your individual circumstances and you should obtain tax advice before making any decisions.

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

Saving through a pension scheme remains one of the most efficient ways to put money aside for later in life. Even the highest earners could be getting £4,500 a year of tax relief, which can add up to a substantial sum over the long term.

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