How to contribute more than your annual allowance to a pension

9 April 2018

The government places two main limits on the amount you can save into a pension scheme. One is the lifetime allowance for total fund size, which in 2017/18 stands at £1 million, and the other is the annual allowance.

The annual allowance, at its current level, limits the amount that you, or anybody else on your behalf, can contribute to your pension in any one tax year. In 2017/18 this limit is £40,000 for most people who have not yet drawn on their pension savings.

Higher earners are, however, not allowed to contribute as much and receive tax relief. Broadly speaking, the annual allowance tapers down by £1 for every £2 of income between £150,000 and £210,000, until it reaches just £10,000 for the highest-earning individuals.

Carry forward

For many higher earners, though, it is possible to make a contribution of considerably more than their annual allowance. A process known as “carry forward” enables any unused annual allowance from the previous three years to be added to the current year’s allowance, providing you were a member of a registered UK pension scheme during those years.

It is, therefore, theoretically possible for some individuals to make a pension contribution of up to £160,000 in one tax year. In such cases it is always important to consider whether the additional pension contribution is likely to mean your total pension fund will exceed the lifetime allowance.

The table below illustrates how carry forward could work for an individual making a large contribution in 2017/18. In the case below the individual could make an additional contribution of £97,000 which, added to their regular contribution of £16,000 makes a total single-year contribution of £113,000.

There is one fly in the ointment: as an individual you cannot contribute more than your earnings in any given year and receive tax relief. You could not, therefore, receive an inheritance of £100,000, contribute it to a pension, and expect to receive tax relief on all of it despite only having earnings of £20,000 during the year in which you made the contribution.

Tax-efficient profit extraction

Your employer, by contrast, can make a contribution of any level to your pension scheme, subject to the annual allowance (including carry forward). If you own your own company then making a substantial employer’s contribution to your pension could be a more efficient way of extracting profits from the business than, for example, paying a dividend.

Profits are subject to corporation tax and dividends attract income tax. A pension contribution is an allowable business expense so can be made entirely tax-free.

When you come to take the money out of your pension 25 per cent will (under current rules) be tax-free. The remainder will be subject to the rate of income tax you are paying at the time – which may be lower than your current rate.

Carry forward can be a very powerful retirement saving tool, particularly for individuals with fluctuating incomes. However, the rules governing pension allowances are complex, and contain a number of very costly bear traps, so we recommend speaking to a qualified, expert financial adviser before making any significant changes to your pattern of contributions.

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