This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
The UK pension system can easily leave people confused. Not only does it deal with finances which seem to be in the far future, but the tax regime and “compounding dynamic” which take place on pension investments can also be quite complicated. There are also a range of pension allowances available which are intended to incentivise people to save towards their retirement, but which often are not clear to most people.
In this short guide, our Elmfield financial advice team here in Padiham, Burnley, Lancashire intends to shed more light on how the UK pension system works in 2020. In particular, we hope to illuminate how the allowances work, and offer some ideas about how an individual can make best use of them. We hope you find this content useful. If you’d like to speak to an independent financial adviser then you can reach us via:
T: 01282 772938
Perhaps the first important pension rule to be aware of is the lifetime allowance. Simply put, this refers to the maximum amount you can save into your pension(s). This tends to rise slightly each year to account for the effects of inflation. In 2020-21, for instance, the lifetime allowance is currently set to £1,073,100. This excludes your state pension but includes schemes like your workplace pension(s) and any private pensions.
Most of us will never need to worry about reaching this threshold (beyond which punitive tax charges apply). Yet it’s important to be aware of it, especially since a pension pot has the power to grow substantially over many decades via compound interest. Senior doctors, for instance, were at risk of breaching the threshold in 2019 due to their higher salaries and generous pension schemes. Speak to your financial adviser if you at all concerned that you might be at risk of exceeding your lifetime allowance in the future.
There are also limits on how much you can put into your pension each year. In 2020-21, you can contribute up to £40,000 per tax year – or up to 100% of your salary (whichever is lower). If you exceed your limit then a tax charge will likely apply. Yet there are some important caveats to this annual allowance that you need to be aware of.
First, the system does allow you to put more into your pension within a given tax year – if you did not take full advantage of your allowances in the previous three tax years. Suppose you earn £40,000 per year and you made £10,000 of pension contributions in each of the 2017-2018, 2018-19 and 2019-20 tax years. This leaves £30,000 of unused allowance in each respective year. Therefore, in 2020-21 you could potentially contribute an extra £90,000 into your pension pot (on top of the £40,000 you were already entitled to put in).
Second, your annual allowance will be reduced if you inadvertently trigger the Money Purchase Annual Allowance (MPAA) rules. In 2020-21, this can lower the maximum you can contribute to your pension from £40,000 to £4,000. An example of a “trigger” of the MPAA might be that you continue working and putting money into your pension pot, whilst also taking an income from the latter. Be careful, therefore, not to unwittingly trigger the MPAA rules by taking money from your pension pot without first consulting your financial adviser.
Taxes on pension contributions
These are the main pension allowances to be aware of in 2020. Yet it’s also crucial to recognise some other vital rules which could unwittingly trip you up:
- The over-55 rule. Since the Pension Freedoms were introduced in 2015, many people have been able to take money out of their pension pot(s) once they reach age 55. Take care, however, not simply to take the money out just because you can. After all, this will reduce the size of your pension pot and could result in you running out of money when you retire (if you do not plan carefully).
- The 25% tax-free lump sum rule. Once you reach age 55, those with a pension pot (i.e. a defined contribution pension) are usually allowed to withdraw up to 25% as a tax-free lump sum. Speak to your financial adviser if you are considering this. Again, whilst this could release some much-needed capital (e.g. to pay off some debts), it could result in a lower income and retirement lifestyle in the future.
- Transfer charges. Sometimes it might be appropriate to consider moving your pension to a different scheme. Perhaps you are retiring overseas and wish to have more flexibility in how you take your income. This can be a wise choice in some cases, but it’s important to discuss the ramifications with your financial adviser. Some schemes levy a charge if you transfer. The government, moreover, may also impose a 25% overseas transfer charge – for instance, if you move from one qualified recognised overseas pension scheme (QROPS) into another.
Conclusion & invitation
If you are interested in starting a conversation about your own situation then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938