Last month we discussed maximising pension contributions under an increasingly restricted annual allowance. For company directors and business owners the annual allowance relevant earnings cap (the maximum you can contribute, based on your income) can potentially be circumvented utilising employer contributions. However, to absolutely maximise tax-efficient pension planning, ‘carry forward’ is king.
To recap; in the last eight years the annual allowance has dropped from £255,000 to a maximum of £40,000. Carry forward literally means you can ‘carry forward’ unused annual allowance from the previous three years, if you were a member of a registered pension at the time (the State Pension doesn’t count).
Who can use carry forward
Anyone with earnings over the annual allowance; but particularly if:
- You are subject to the tapered annual allowance (a restriction for people with high earnings)
- Your income varies significantly year-on-year
- You have had an especially profitable year and would like to make large pension contributions
Four golden rules
- Your current year’s annual allowance must be used first, before exploiting previous years
- The earliest available unused allowance of the previous three should be used next
- The contribution doesn’t have to be paid to the same pension you were a member of in previous years
- Personal contributions must always remain within 100% of your relevant earnings (which is employed income, not dividend, investment or pension income), but remember, this does not apply to employer contributions made from your business
You now have two choices:
- If you would like to maximise pension contributions for retirement planning or to reduce tax liability, we would be very happy to calculate the contributions you can make on your behalf. To do so, please call the office.
- Or, if you would like more details, please read on…
Your Pension Input Amount
To calculate your previous contributions, it is necessary to know the total Pension Input Amount (PIA) for a Pension Input Period (PIP) ending in each tax year:
- For Defined Contribution arrangements (Personal Pensions, SIPPS, some workplace pensions), the PIA is the total of all contributions paid. Simple.
- For Defined Benefit schemes, otherwise known as Final Salary pensions, the PIA is calculated as the increase in value of the benefits over the Pension Input Period.
The 2015/16 transitional year
To complicate matters, the 2015 Budget aligned PIPs with tax years. This applied to all pension schemes. For the purposes of the annual allowance 2015/16 (the earliest year you can benefit from carry forward) was split into two mini tax years; ‘Pre-alignment’  and ‘Post-alignment’ .
The Pre-alignment mini tax year ran from 6 April 2015 to 8 July 2015. Post-alignment ran from 9 July 2015 to 5 April 2016. The annual allowance for the Pre-alignment period was £80,000 and £0 for the Post-alignment period. Any unused annual allowance from the Pre-alignment period could be used in the Post-alignment period, capped at a maximum of £40,000.
Only unused annual allowance from the Post-alignment period can be carried forward, aligning the £40,000 maximum with future years.
Let’s consider some examples:
A business owner with an irregular income, unaffected by tapering, and a very profitable 2018. In this example, using carry forward, the business owner can make a tax-free pension contribution of £145,000 in 2018/19:
|Pension Input Period||Annual allowance||Pension Input Amount||Available to carry forward||Allowance with carry forward|
A high earner with income above adjusted and threshold limits (hence qualifying for tapering), making regular contributions. Carry forward regularly allows a contribution higher than the tapered annual allowance to be paid year-on-year:
|Pension Input Period||Annual allowance||Tapered annual allowance||Pension Input Amount||Available to carry forward||Allowance with carry forward|
Claiming carry forward
There is no formal requirement to make a claim with HMRC of the use of carry forward. However, it’s very sensible to keep a record in case they ever require evidence.
A final word
Calculating carry forward is not beyond the realms of the financially savvy, but if you’ve made it to the end of this article, you’ll appreciate how complicated it may be. If you value your sanity, it may be worth talking to one of the Choice team! Remember, we’re here to help: 02380 633377.