It’s the time of year when all good advisers will be talking to their clients about making the most of any unused allowances. This year, there will be extremes when it comes to the fortunes of clients: those whose income has dropped significantly so they have little to save or invest; and those whose income has been relatively unaffected, but whose spending has fallen dramatically so they have more of a surplus than usual.
For the fortunate, using their allowances is more relevant than ever for those excess funds.
But for those who’ve taken a hit this year, it’s a different story. One small piece of good news is that, unlike many other allowances, unused pension allowance from the three previous tax years can be carried forward – so it’s not a case of ‘use it or lose it’.
This can be useful in a few different scenarios.
Maximising tax relief
First, there are those who have taken an income hit this year but have good prospects of being in a better position in the next year or two. This will include those who have been furloughed at some point in the year, or potentially those who have fallen outside the various Government support schemes – think self-employed – but still have a good business model and chances of profitable years ahead.
Even if individuals have some funds to make personal pension savings this year, would they be doing so at a lower rate of tax than usual? For example, take someone who might usually have UK relevant earnings of £100,000+ but this year only earned £40,000. They may have sufficient resources to make a £40,000 contribution this year – but they’d only get tax relief at 20%. If they instead wait until their earnings recover, they could potentially get 40% (or more) relief.
There may be a benefit in waiting for anyone whose income is likely to increase and tip them into the next tax band, be it basic/higher or higher/additional, and not forgetting those whose earnings are pushing the £100,000 barrier, so start losing their personal allowance. This should be balanced with the potential loss of investment growth caused by delaying.
When we head north of the border to Scotland, there’s even more potential for clients to be on the boundaries with five tax bands to navigate.
None of us yet know how 2021/22 is going to pan out, but the fact you can go back three years to use up unused annual allowance does give a bit of flexibility that might benefit more people than usual in current circumstances.
The important rules to remember for carry-forward are that the individual must have sufficient earnings (dividends and property income will not count) in the tax year they actually make the personal contribution, and they must have been a member of a UK registered pension scheme in the year they are carrying forward from.
Secondly, we have very high earners, and some will continue to fall into this bracket. This group may be used to having to wait until after tax year end and then carrying forward unused allowance, as for those impacted by the taper it is often impossible to know your allowance before tax year end.
There will be far fewer people in this position for 2020/21 than in previous years. This is due to the big increase in the income thresholds for the taper, coupled with many people experiencing a drop in income in the tax year. In 2020/21, only those with threshold income of over £200,000 (broadly all earned income plus investment income) and adjusted income of over £240,000 (broadly threshold income plus employer contributions) are impacted by the taper. Previously, these limits were £110,000 and £150,000 respectively. When calculating what carry-forward is available for clients, the effects of tapering will need to be taken into account.
All of this means that, whilst advising clients to make the most of their allowances is usually sound logic, there are times when waiting may be the best policy.
This article was previously published by Professional Paraplanner
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