Have you considered your planning for Pensions Awareness Month?
Each year, September is classed as ‘Pensions Awareness Month’, one dedicated to raising awareness of the importance of saving and planning for retirement. Accountants are not usually regulated pension advisors, so do not give investment advice, but are well placed to plan cashflow, profits and taxes for maximising the potential benefits of pension contributions.
What should I be thinking about?
Affordability - how much cash can you afford to lock away in a pension until you are at least 55 (or older for future years)?
Profits - how much can the business afford to contribute to pensions out of profits and working capital?
Tax - what are the tax benefits of making pension contributions versus cash in the bank or other investments (such as ISAs)?
Allowances - how should you make best use of annual allowances? Remember you can carry forward your unused annual allowances for 3 years plus the current tax year but you must fill your allowance for this year before back-filling unused allowances.
Pension updates in Spring Budget
As a reminder there were significant changes to pensions announced in March 2023 with effect from 6 April 2023 summarised below:
- Increase in the Annual Allowance from £40,000 to £60,000.
- Increase in the Money Purchase Annual Allowance from £4,000 to £10,000.
- Increase in the income level for the tapered Annual Allowance from £240,000 to £260,000.
- Measures to ensure that nobody will face a Lifetime Allowance charge.
- Limit to the maximum an individual can claim as a Pension Commencement Lump Sum to 25% of the current Lifetime Allowance (£268,275), except where previous protections apply.
- Change to the taxation of the Lifetime Allowance excess lump sum, serious ill-health lump sum, defined benefits lump sum death benefit and uncrystallised funds lump sum death benefit, where they are currently subject to a 55% tax charge above the Lifetime Allowance, to taxation at an individual’s marginal rate.
There are two common questions raised concern the allocation of tax relief on pension contributions:
Where the employer makes contributions into a registered pension scheme with HMRC, the contributions are used to reduce the value of trading profits assessable to Corporation Tax. Essentially, they are regarded as an allowable trading expense and are a necessary cost incurred as a result of employing workers. For owner/managers of trading Limited Companies this offers a potential Corporate Tax saving of up to 25% on an employer contribution for accounting periods starting 1 April 2023.
The employee is entitled to Income Tax relief on their contributions. This is far from simple and HMRC used their August 2023 Employer Bulletin to say they are aware of employers making mistakes in providing the relevant tax relief. There are two methods:
- The Net Pay Arrangement (NPA) – this is where tax relief is given when pension contributions are taken out of their pay by their employer before Income Tax is calculated. This means tax relief is given at the employee’s marginal rate of tax (20%, 40%, 45% etc), or
- The Relief at Source (RAS) Arrangement – where the pension scheme claims tax relief at the Basic Rate (20%) from HMRC, as employees make pension contributions from earnings after Income Tax is calculated (individuals who pay tax at rates higher than the Basic Rate can claim extra relief directly from HMRC)
Action for Employers
It is small wonder employers are confused about tax relief on employee pension contributions as the two mechanisms are confusingly named. Remember:
- NPA gives tax relief by reducing taxable pay before Income Tax is calculated
- RAS tax relief does not reduce taxable pay and ‘the source’ (the payroll) reduces the pension contribution by 20%
If the incorrect method of Income Tax relief is given, this is, indeed, a major issue that needs to be corrected, often resulting in long work that involves pay period by pay period recalculations, sometimes going back several tax years. The top tips, therefore:
- Check you are using the method of tax relief contained in the pension scheme rules - ‘rules always rule’!
- Check that payroll software is set to give the appropriate method of tax relief. Both the NPA and RAS mechanisms have been around for years and there should be no reason why payroll software cannot accommodate either (or, sometimes, both if more than one pension scheme is operated with different scheme rules)
If the wrong method has been used, contact HMRC as soon as possible using their digital disclosure facility. This can be used for any tax, not just Income Tax