Are you overcontributing to your pension?
When building up your pension it is important to be conscious of what limits apply in order to maximise the full tax benefits.
Thousands of people across the UK are experiencing tax charges for overcontributing to their pensions and most don’t even realise. According to HMRC over 50,000 people reported pension contributions that exceeded their ‘Annual Allowance’ (AA) in 2021-2022. This number has been skyrocketing since 2010 and has increased by 10,000 people since 2020-2021, when only approximately 40,000 exceeded their Allowance (Please see chart below).
Figure 1. Number of individuals and value of pension contributions exceeding the AA reported through SA 2006 to 2007 to 2021 to 2022, Source: UK Government
Often people don’t even realise that they are overcontributing until it is too late. So, why are so many people being caught out?
Arrange your free initial consultation
What is an Annual Allowance?
Although there is not a limit on the amount that can be saved into pensions each year, there is a limit on the amount that can benefit from tax relief each tax year. An individuals ‘Annual Allowance’ is the limit that you can contribute to your pension in any tax year whilst benefiting from tax relief. The current annual allowance is £60,000, however, you can only receive tax relief up until your net relevant earnings. Net relevant earnings are the total earnings from salary, bonuses, benefits in kind and trading profits for self-employed individuals in a tax year. So, if your salary is £40,000 for example, you would only receive tax relief up to £40,000, but if it is £80,000, in most cases, you would only receive tax relief up to £60,000 in one tax year.
What if I exceed my Annual Allowance?
If you exceed this allowance in a tax year, any contributions above the limit will typically be subject to an annual allowance tax charge. This excess will be added to your taxable income and be subject to income tax at your marginal rate. In some cases, you might be able to ask your pension scheme to pay the charge from your pension. This is known as Scheme Pays and means your pension would be reduced, but this is not always possible.
Why are people overcontributing?
Although the annual allowance sounds straightforward, there are some caveats that make understanding it a lot more complex. Where your net relevant earnings are more than £60,000 a year and have been a member of a registered pension scheme for more than three years, you may have the ability to use carry forward allowances. If you have not used your full annual allowance from any of the previous three tax years, you can carry this allowance over to the current tax year. This can cause confusion and miscalculations regarding exactly how much more an individual can contribute using carry forward.
Those who have a high income are also subject to more complex rules with regards to their annual allowance. For every £2 of adjusted income (i.e. total taxable income before any Personal Allowances and less certain tax reliefs) that an individual earns over £260,000 their annual allowance is reduced by £1, to a minimum of £10,000. This means that anyone with an income of £360,000 or more has a reduced annual allowance of £10,000.
Another caveat that trips people up is that, in some cases, the annual allowance reduces to £10,000 per tax year when an individual begins drawing down or withdrawing from their pension. This is often triggered for those who are flexibly accessing a defined contribution scheme. It is worth noting this is not the case for all withdrawals, for example when taking a Pension Commencement Lump Sum (PCLS) or annuity. When this reduced allowance comes into effect, carry over cannot be utilised anymore. This can often catch people out and cause them to overcontribute because they think they have more allowance than they do.
It is also worth remembering your annual allowance takes into consideration all contributions to all of your private pension schemes. Therefore, it is not only your personal contributions that count towards the annual allowance, but your employer contributions as well. For those who are fortunate enough to have a Defined Benefit (DB) scheme, otherwise known as a final salary scheme i.e., a pension that traditionally pays out a guaranteed income every year in retirement, calculating the remaining annual allowance is more complex. Any further accrual in a Defined Benefit scheme in a tax year contributes to the annual allowance. These additional complexities make calculating the annual allowance year on year more difficult to understand. As a result, many people find themselves overcontributing and incurring a tax charge without even realising.
Taxation on pension funds has become a hot topic since the 2023 Spring Budget announcement about the intention to remove the ‘Lifetime Allowance (LTA)’. The LTA is the total contributions that one can make to a pension over their lifetime without incurring certain tax charges. Those who weren’t overcontributing prior to this, for fear of exceeding the LTA, have more incentive to re-commence contributions. However, with a general election expected in the autumn of 2024, these changes could be reversed.
If you’re concerned, we can help. With more people than ever exceeding the annual allowance, it is important to be aware of the many factors that need to be considered when calculating how much you should be contributing to a pension. If you have any questions about the annual allowance, or think you might be at risk of a tax charge due to miscalculations; then please get in touch with your Financial Adviser or consider seeking advice.
Arrange your free initial consultation
This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.
The information in this article is based on current laws and regulations which are subject to change as at future legislations.
A pension is a long-term investment. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
The Financial Conduct Authority (FCA) does not regulate tax advice.
How to make your child a millionaire before 40!
Most parents would like to ensure their children have a strong financial footing when they are older, but don’t always know the best way to do this. There are many ways to support your children financially throughout their lifetime, but what if there was a way to make them a millionaire before they even reached retirement age? Here we look at the best ways to put money aside for your children and how you can maximise the benefits of compound interest to make your child a “millionaire”!
Arrange your free initial consultation
The first step to saving for your children’s future is understanding your saving options. Here are the most common options that benefit from tax-free growth:
Junior ISA(JISA)
From the day a child is born you can put money into a JISA for them. The current contribution limit is £9,000 per tax year (or £750 per month) and you have the choice of a Junior Investment ISA or a Junior Cash ISA. The most important benefit of a JISA is that any gains made, or interest earned will be tax-free!
If we assume you receive an average annual net return of 5% per year and you save the maximum of £9,000 every tax year, from the day your child is born until they turn 18, you will have contributed a total of £162,000 to their account. However, due to the magic of compound interest (where you earn interest on interest), they will have a pot of over £265,000 saved in a tax-efficient wrapper, what a great 18th birthday present!
At their 18th birthday they can transfer their JISA into an Adult ISA to continue to receive tax-free interest/ investment returns.
Junior Self-Invested Personal Pension (Junior SIPP)
Setting up a pension up for your children may seem like you are overly preparing but this can actually give your children a significant head start. The maximum you can currently save into a Junior SIPP is £2,880 per tax year, and the UK government will add tax 20% tax relief of £720 per tax year, which would bring the total contribution to £3,600. If you can contribute to your child’s Junior SIPP for 18 years and again assuming a 5% growth rate, you will have contributed £51,840 but their pension pot will be worth £106,340 due to the added tax relief. If your child doesn’t contribute to the pension again, by age 57* they could have a pension pot worth around £712,986. Similar to the JISA, any gains made within the SIPP are exempt from tax, and based on current pension rules, you can take up to 25% as a tax-free lump sum upon reaching retirement age.
Recent statistics released by the Office for National Statistics (ONS) stated how the average pension wealth for all persons in the UK is £67,800 at age 57*, highlighting how starting to save early can set your child up for their future and give them a greater opportunity in retirement or even to retire early.
How to make your child a millionaire!
And this is how to do it! If you do the following and assume a 5% growth rate per annum:
- Open a JISA before your child’s first birthday and contribute £9,000 every year until age 18. This results in a total contribution of £162,000 (18 years x £9,000).
- Open a Junior SIPP before your child’s first birthday and contribute £3,600 (including tax relief) to the Junior SIPP every year up to their 18th birthday. This totals 18 years x £2,880 (or £3,600 with tax relief) which equals £51,840 (£64,800)
This would mean you will have contributed a total of £226,800 (including tax relief) to the JISA (£162,000), and Junior SIPP (£64,800). At age 18 when you stop contributing, they could have a total net worth of £372,191 when taking into account compound interest and growth. If they leave this money invested and continue to achieve 5% per year growth, by age 39 they could have a total net worth of just over £1million (£1,036,911), although the funds in the pension would not be accessible until age 57*.
At that point the pension fund could have grown to £712,986, while the ISA, could be worth £1,782,465 if it remained untouched too - an extraordinary total of almost £2.5m. That is a gift worth giving.
The power of starting to save early
Using the same assumptions as above, with a 5% annual growth rate and maximising both Junior SIPP and JISA contributions until age 18:
Starting from date of birth | Starting at age 5 | Starting at age 10 | |
---|---|---|---|
JISA Value at age 30 | £477,430 | £300,604 | £162,056 |
Junior SIPP value at age 30 | £190,972 | £120,242 | £64,823 |
Total Value at age 30 | £668,402 | £420,846 | £226,879 |
This shows the benefits you can provide by starting the process of saving early for your child through compounding the interest or investment returns. This is a representation of how you can save for your children and assumes maximum contributions are made at each birthday, but we understand the circumstances for each parent and child will be different and may require different forms of financial planning, such as monthly contributions instead of lump sums.
Despite the examples above, it is never too late to start. If you would like to understand how, The Private Office can structure savings and investments for you and your children to help provide the whole family with a strong financial future. So why not get in touch for a free initial consultation.
* Based on current pension regulation, where the normal minimum pension age is increasing to age 57 from April 2028.
If you would like to know more about this topic, one of our Partners Kirsty Stone appeared on BBC Radio 4 Money Box live, giving her suggestions in a programme all about saving for children.
Arrange your free initial consultation
This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.
All the calculations in this article assume that lump sum contributions are made for 18 years, from birth, unless otherwise stated, to the 17th birthday and are not adjusted for inflation.
The Financial Conduct Authority (FCA) does not regulate tax or cash advice.
The growth rates provided are for illustrative purposes only. Investment returns can fall as well as rise and are not guaranteed. You may get back less than you originally invested. Investments may be subject to advice fees and product charges which will impact the overall level of return you achieve.
Living to 100 years - are you financially prepared?
The number of individuals aged 100 or older in England and Wales has reached an all-time high.
In September 2023, the Office for National Statistics (ONS) released statistics showing that over the past century, the number of centenarians living in England and Wales has increased 127-fold, shown in Figure 1 below. Figures are reported to have hit a record high of 13,924 centenarians in 2021; of this number of centenarians, 11,288 were women and 2,636 were men.
Figure 1. The number of centenarians in the population increased rapidly from the second half of the 20th century, Source: Historic Census data (1991 to 2021) from the Office for National Statistics
ONS report the UK ranking as the seventh country worldwide for highest number of centenarians and in 2021, the ONS reported that there has been a 24.5% increase from 2011 of centenarians living in England and Wales.
Although an ageing population is a major achievement of modern science and healthcare, the rise in the UK’s ageing population raises concerns around financial planning and retirement readiness.
Arrange your free initial consultation
So, how can living longer affect your own financial planning and retirement readiness?
Whilst the news that an increased number of individuals living longer in England and Wales is good news at the surface level, the challenge to this is that there is a greater need for people to acquire sufficient pension savings to fund a longer retirement.
This issue was identified by the World Economic Forum in 2019, where their findings showed that people may be expected to live longer than the pot of money they have saved for retirement by between 8 to almost 20 years on average. Han Yik, Head of Institutional Investors Industry at the World Economic Forum, stated that “The real risk people need to manage when investing in their future is the risk of outliving their retirement savings”.
Earlier this year, the below estimates were calculated by Interactive investor, using the Pensions and Lifetime Savings Association (PLSA) Retirement Living Standard:
A 65-year-old living to Age 84 would require a starting fund value of £212,000.
Whereas a 65-year-old living to Age 100 would require a starting fund value of £324,000.
These figures indicate that someone expecting to live to 100, compared to the current average life expectancy would need around a further 54% in the starting value of their retirement savings.
It is important to note that these calculations assume that the individual is entitled to the full State Pension of £10,600 p.a. and they also own their home, therefore having no rent or mortgage costs.
Whilst the UK Government provides the State Pension to qualifying individuals, which can provide a solid foundation for retirement, this needs to be supplemented to ensure a genuinely comfortable later life. Although it is technically possible to live on the state pension, additional incomes sources are crucial for a more comfortable and enjoyable retirement. And that’s before the likelihood of further costs to consider such as at-home Care or Care Home needs.
How can you be better prepared for your financial future?
Starting your financial planning as soon as possible brings many benefits including possible higher return on your investments, time to weather market volatility and ability to take more risks.
A key tool used when giving financial advice and looking ahead to your financial future is cash flow modelling. Cash flow modelling helps you to visualise what your future could look like, and then more importantly, what needs to be done before then. For example, it helps you answer questions such as:
- “How much do I need to start saving in order to retire at age 60?”,"If I was to require Care, would I be able to afford it?”, etc.
While we can make sensible assumptions, the one difficult thing to predict is one’s life expectancy. With the general population living far longer, it’s important to take a cautious approach and always overestimate, which is why we usually plan our cash flow models to age 100.
A good place to start planning your future is by understanding where you are now within your financial planning journey and what your life goals and expectations might be. A useful tool to get a basic understanding of this is our retirement calculator. From your own inputs, you will be able to forecast an estimate of the pension income you will get when you retire and receive a target retirement income to aim for based on your choices, taking into account your salary.
Arrange your free initial consultation
This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions.
A pension is a long-term investment. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
The Financial Conduct Authority (FCA) does not regulate tax advice or cashflow modelling.
Autumn Statement – what the announcements mean for your finances
Chancellor Jeremy Hunt promised to ‘reduce debt, cut taxes and reward work’ in his ‘Autumn Statement for growth’, but what might the changes he announced mean for your personal finances?
In the lead up to the Autumn Statement, we discussed the changes that were rumoured to have been announced in this article.
Arrange your free initial consultation
These speculated changes included:
- Reducing Inheritance tax
- Announcing an additional ISA allowance for investment into UK companies
- Changing the state pension triple lock calculation to limit next year’s state pension increase
In the end, none of these changes were introduced, with shadow chancellor Rachel Reeves claiming Hunt wanted to reduce inheritance tax but that he “couldn’t get away with it in the middle of a cost of living crisis”. Instead, the headline grabbing change was the 2% reduction to employee national insurance contributions between £12,571 and £50,271. This will equate to an annual saving of c. £754 p.a. to those earning over £50,270 p.a. with effect from January 2024. Additionally, there were National Insurance reductions for the self-employed, with Class 2 contributions effectively abolished and Class 4 contributions reduced from 9% to 8% between £12,571 and £50,271 with effect from April 2024.
However, this will only go part of the way to make up for the impact of the continued freezing of the income tax bands, which will remain frozen until 2028. Indeed, as a result of higher inflation, higher interest rates and frozen tax bands, the Office for Budget Responsibility (OBR) states “Living standards, as measured by real household disposable income per person, are forecast to be 3.5 per cent lower in 2024-25 than their pre-pandemic level.”
Separately, the speculated ISA allowance increase for investments into UK companies did not materialise and pensioners will be pleased to hear Mr Hunt state the government will “honour our commitment in full” as the state pension rises by 8.5% next year.
Regarding pensions, workers will hope a new legal right for their new employer to pay into their previous defined contribution pension scheme will simplify pension planning going forward and will mean an end to the accumulation of multiple schemes as individuals move between companies.
This was an Autumn Statement with half an eye on an upcoming general election, with announcements that should put more money in the pockets of workers and pensioners alike. Mr Hunt repeatedly referred to the OBR’s forecasts during his announcement as he tried to rebuild credibility, a little over a year after Liz Truss and Kwasi Kwarteng’s ‘mini-budget’, prior to which the OBR was not asked to run forecasts. Overall, Mr Hunt will have been grateful that he was able to use some of the fiscal headroom provided by then Chancellor, now Prime Minister, Rishi Sunak’s decision to freeze income tax bands back in 2021 to offer a national insurance cut and significant state pension rise to the voting public.
Arrange your free initial consultation
The opinions shared in this article are solely those of the individual and they do not necessarily reflect those of The Private Office.
Approaching Retirement Guide
![Approaching Retirement Guide](/sites/theprivateoffice/files/documents-centre/guides-and-tools/pensions/apporaching-retirement-thumbnail.jpg)
Your guide to designing your stress-free retirement
Defined Benefit Pension Transfer Guide
![Defined Benefit Pension Transfer Guide](/sites/theprivateoffice/files/documents-centre/guides-and-tools/pensions/db-pensions-guide-thumbnail.jpg)