As the end of the 2023/24 tax year approaches, it’s time to turn your attention to one of the most tax-efficient saving vehicles – your pension. By making strategic contributions before 6th April 2024, you could secure valuable tax relief, top up your retirement nest egg, and maximise unused allowances from previous years. But with various caps, thresholds and tapering rules to navigate, it’s important to understand how the system works to optimise your savings.

The Earnings Cap Explained

The first key limit to be aware of when making pension contributions is the earnings cap. In essence, the amount you can personally pay into your pension while benefiting from tax relief is limited to 100% of your earnings in the tax year. So, if your salary is £50,000, you can make up to £50,000 of tax-relieved personal contributions.

If you have no earnings or are below £3,600, you can still contribute up to £3,600 gross (equivalent to a £2,880 net contribution with basic rate tax relief added).

It’s important to note that ‘earnings’ for pension purposes only include salary, bonus and taxable benefits. Many company directors choose to extract much of their income as dividends, but these don’t count towards the earnings cap. If your remuneration is heavily geared towards dividends, it can limit the scope for personal pension contributions.

However, this is where employer contributions come into their own. Crucially, contributions made by your employer (including your limited company, if applicable) are not subject to the earnings cap. This means your company can contribute more than your earnings figure and still benefit from tax relief. Moreover, employer contributions are normally fully deductible for corporation tax purposes, making them a highly tax-efficient way to extract profits.

Navigating the Annual Allowance

The second key limit on pension savings is the annual allowance. This caps the total amount that can be paid into your pension each tax year while still benefiting from tax relief. Importantly, the annual allowance considers your contributions and any amounts paid in by your employer.

The standard annual allowance for the 2023/24 tax year is a generous £60,000. However, for high earners, there is a nasty sting in the tail. Under the ‘tapered annual allowance’ rules, your allowance will be reduced by £1 for every £2 your adjusted net income exceeds £260,000 – down to a minimum allowance of just £10,000.

To add to the complexity, there are two income definitions used to assess tapering:

1. Threshold income – broadly your taxable income excluding pension contributions. The taper only kicks in if this exceeds £200,000.
2. Adjusted net income – broadly your taxable income, including pension contributions. If your threshold income is over £200,000, the taper applies £1 for £2 on any adjusted net income above £260,000.

To avoid falling foul of the taper, assessing your full income position and planning your contributions accordingly is important. Sometimes, making additional contributions to stay within the thresholds can be more beneficial than saving above them and losing allowances.

Using Up Past Years’ Allowances

One of the most valuable – but often overlooked – features of the annual allowance system is the ability to carry forward unused allowances from previous years. If you haven’t fully used your allowance in the last three tax years, you can still utilise those amounts this year on top of your 2023/24 allowance.

The key point to remember is that allowances from earlier years must be used in order – so you first utilise any unused allowance from 2020/21, then 2021/22, then 2022/23. And vitally, 2020/21 allowances will be lost after 5th April 2024, so this year is your last chance to benefit from that extra capacity.

It’s worth noting that the allowances in previous years were set at different levels to the current £60,000 limit:

• 2020/21: £40,000 standard allowance, tapering down to £4,000 for adjusted net income over £240,000
• 2021/22: £40,000 standard allowance, tapering down to £4,000 for adjusted net income over £240,000
• 2022/23: £40,000 standard allowance, tapering down to £4,000 for adjusted net income over £240,000

So, when assessing your available carry forward, ensure you use the right figures for the year. If in doubt, seeking professional advice can help ensure you make the most of these valuable extra allowances.

The Lifetime Allowance Charge Abolition

One major change for the 2023/24 tax year is abolishing the dreaded lifetime allowance charge. Previously, if your pension savings exceeded the lifetime allowance (set at £1,073,100 for 2022/23), any excess would be subject to a punitive tax charge of up to 55% when withdrawn.

However, in a welcome move, the Chancellor scrapped the lifetime allowance charge on 6 April 2023 and abolished the lifetime allowance itself on 6 April 2024. This paves the way for those with larger pension pots to contribute further without fear of triggering a hefty tax bill.

That said, there is still a cap on the maximum tax-free cash you can take from your pension at retirement. If your pension savings exceed £1,073,100 when accessed, the tax-free lump sum will be limited to £268,275 (25% of £1,073,100). However, for many, removing the lifetime allowance charge will be a major incentive to ramp up pension savings in the coming years.

Don’t Forget the MPAA Trap

While the annual and lifetime allowances are the two main limits to watch out for, one other cap can catch the unwary—the money purchase annual allowance (MPAA).

If you’ve flexibly accessed any defined contribution pension savings (e.g., taking taxable income via drawdown or withdrawing more than 25% tax-free cash), you’ll be subject to the MPAA of £10,000 on further contributions in 2023/24. This is a sharp reduction from the standard £60,000 allowance and includes personal and employer contributions.

The MPAA is designed to prevent ‘double-dipping’ by recycling pension withdrawals back into a pension to claim extra tax relief. But it can be a major hindrance if you access even a small amount flexibly and later want to ramp up saving again. So, if you’re considering dipping into your pension, weighing the long-term impact on your contribution capacity is important.

Planning Your Year-End Contributions

With the key limits and allowances in mind, now is the perfect time to review your pension savings for the 2023/24 tax year and assess your contribution options before 6th April.

Some key steps to consider:

• Assess your earnings cap and annual allowance position to determine how much you can contribute personally and/or via your employer.
• Review your threshold and adjusted net income position to determine if tapering applies and plan your contributions to stay within the thresholds where beneficial.
• Check if you have any unused annual allowance from the previous three tax years that can be carried forward – but remember, 2020/21 allowances will be lost after this year.
• If you were previously capped by the lifetime allowance, consider whether additional contributions are appropriate now that the charge has been abolished.
• If you’re a high earner with a limited earnings cap, explore the potential for employer contributions to maximise savings.

By taking a proactive approach and seeking advice where needed, you can ensure you’re making the most of the available tax breaks and securing your financial future. So, don’t let the tax year-end pass you by without giving your pension some much-needed TLC – your future self will thank you for it.