With changes to the pension lifetime allowance announced earlier this year, now is the perfect time to make sure you have a pension plan that supports your goals for the future. Jason Million, Chartered Financial Planner at Everlong Wealth, shares his top pension planning tips for high earners getting started.
For maximum effectiveness – and maximum savings – pension planning should begin long before you actually retire. There is no such thing as ‘too soon’ to start planning and preparation is essential to make sure you have enough money to enjoy a comfortable retirement and fund your future plans.
There are three key strategies you should prioritise within your pension planning as a high earner: tax-efficient income planning, later life protection and inheritance tax planning.
If your retirement was a book, these strategies could be viewed as separate but connected chapters. While successful pension planning for high earners involves several more chapters and a much more in-depth narrative, the three areas we summarise below provide solid foundations for you to build on.
Tax-efficient income planning
It is highly likely that your current income is the main source of funding for your pension, which means it is vital you take a proactive approach to tax efficiency. This is especially important in pension planning for high earners, as you face more tax liabilities than the average taxpayer.
The good news is there are various ways you can improve your tax efficiency with the use of pension planning. Pension planning inevitably involves making contributions to your pension, which has a number of financial benefits:
- Tax relief – The relief on your pension contributions is calculated according to your income tax rate. For high earners, this is usually 40 to 45%. If you earn more than £100,000 and take into account the impact on personal allowance, your effective tax relief could be up to 60%.
- Income tax in retirement – Many high earners end up as basic rate taxpayers in retirement.
- 25% tax-free – You can typically withdraw up to 25% of your pension fund as a tax-free lump sum.
- Tax-free growth of your pension fund (compound investment growth) – Any money added to your pension fund has the potential to generate a return that is not taxed until you draw an income from your pension. This allows your pension fund to grow without any tax reductions, which means you have a larger sum of money that benefits from compound investment growth. Compound investment growth is when you re-invest your investment returns so they can also benefit from future growth, resulting in ‘growth on the growth’.
Pension planning is also a very useful tool for strategically navigating the various tax thresholds that surround allowances and benefits. For example, your pension contributions can help you stay under the £100,000 threshold for Personal Allowance to continue claiming without being subject to high earner charges.
High earners are also likely to be affected by the High Income Child Benefit Charge (HICBC). Anyone with an income over £50,000 will be charged an amount equivalent or equal to the Child Benefit they are entitled to for every £100 of income they earn above the £50,000 threshold. Pension contributions can bring your income under the threshold and allow you to continue claiming Child Benefit.
It is important to remember that your pension contributions are tax-free up to £60,000, provided the total sum of your contributions in one year is less than your annual earnings – any contributions that exceed your yearly income or the £60,000 threshold will be subject to tax.
Later life protection
The main purpose of a pension is to ensure you have enough money to live off once your working life has ended. Increasing the value of your pension pot through additional contributions will provide you with greater financial security once you reach later life and retirement, as well as lessen any worries about when your money will run out.
An often overlooked but significant cost in later life and retirement is the cost of care. Many of us will face substantial care fees if we are fortunate to live long enough – according to the Association of British Insurers (2015), 1 in 3 people will require some form of care before they pass away. It is essential to consider all the costs you could incur during retirement, including those associated with ageing.
Maximising the value of your pension fund can help to cover potential care costs and comes with the added benefit of HMRC’s helping hand in the form of tax relief on your contributions.
Taking care of future generations is the number one priority in wider retirement planning for many of our clients. To make sure that as much of your estate as possible is passed onto your children or loved ones, you need to lessen the impact of inheritance tax (IHT) on your wealth.
The current inheritance tax threshold is £325,000 – if your estate is worth more than this sum, you are subject to pay 40% tax on anything above the threshold, although you may be eligible to claim £175,000 in tax relief via the Residence Nil Rate Band.
Your pension fund is exempt from inheritance tax and other taxes, which makes pension planning a good way to protect your wealth from HMRC – for example, a £1,000,000 pension fund may not only provide you with a comfortable retirement but shield that money from inheritance tax.
After you die, your pension can be transferred over to your beneficiaries, making it an effective method of passing on wealth without the impact of inheritance tax.
What is the pension lifetime allowance?
The pension lifetime allowance is a limit on the amount of money that you can accumulate across pension schemes without being subject to tax charges. Until April 2024, the pension lifetime allowance was £1,073,100, although this may be higher if certain protections are claimed.
How will the pension lifetime allowance changes affect me?
From April 2024 onwards, the pension lifetime allowance is set to be abolished, which means there will be no limit on the amount of money you can hold in your pension schemes.
However, it is important to note that the Annual Allowance (how much money you can pay into your pension in one year without being subject to tax on your pension contributions) will remain in place. The current Annual Allowance is £60,000. As a high earner, the tax relief you can claim on pension contributions may be restricted further by the ‘Tapered Annual Allowance’.
What is Tapered Annual Allowance?
The Tapered Annual Allowance affects anyone with a threshold income (your total taxable income for the year) in excess of £200,000 and an adjusted income (your total taxable income before any Personal Allowances and after certain tax reliefs have been deducted) over £260,000.
If you are affected by Tapered Annual Allowance, £2 will be deducted from your Annual Allowance for every £1 of income that exceeds £260,000. For example, if your adjusted income is £280,000, your Annual Allowance will be reduced to £50,000.
If your adjusted income is £360,000 or more, your Annual Allowance will be fixed at £10,000. You can ‘carry forward’ any unused allowance for up to three years.
Pension planning – one part of your big picture
The most successful pension planning takes place within a wider, carefully designed wealth management strategy that is tailored towards achieving your financial objectives. At Everlong Wealth, our team of chartered financial planners use a simple, three-stage consultation process to understand your financial DNA and create a bespoke strategy that incorporates the services we offer that best serve your goals and needs.
Contact us today for a commitment-free discussion about your finances.
The information contained within this document is based upon current legislation. The tax treatment depends on the individual circumstances of each client and may be subject to change in future.