Pension contributions – a waiting game?

This time two years ago, I wrote about when not to use your pension annual allowance. This year, this decision is particularly pertinent.

There will be extremes when it comes to the fortunes of your clients in the last twelve months – some will have experienced a significant drop in income, so they have little to save or invest, whilst others will have found their income has been relatively unaffected, but their spending has fallen dramatically so will have more of a surplus than usual.

For the fortunate, using their allowances with those excess funds is more relevant than ever.

But for those who’ve taken an income 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’.

For those who still have good prospects of being in a better position in the next year or two, waiting could be a wise move. 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 have a strong chance of profitable years ahead.

Even if these clients have some funds to make personal pension savings this year, would they be doing so at a lower rate of tax relief than usual? For example, take someone who might usually have UK relevant earnings of £100,000+ but this year only had income of £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 income recovers, they could potentially get 40% (or more) relief.

There may also 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 income is pushing the £100,000 barrier, so they start losing their personal allowance. For Scottish residents, there’s even more potential to be on the boundaries as there are five tax bands to navigate.

Of course, delaying any contributions should be weighed up against the potential loss of investment growth caused by the delay.

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 are that the individual must have sufficient earnings in the tax year they make the personal contribution (investment income won’t count), and they must have been a member of a UK registered pension scheme in the year from which they are carrying forward.

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 Sipps Professional