As of the 6 April 2024, the Lifetime Allowance (LTA) which was first introduced in 2006, is officially gone.
The LTA had an impact on many high-earners and business owners when funding their pensions, particularly if they already had substantial sums saved. This is because they risked any excess over the LTA potentially being taxed at a maximum rate of 55%.
This meant that many people have not contributed to a pension arrangement for several years, whilst continuing to build their wealth elsewhere.
With the abolition of the LTA, pensions are now back on the agenda for those previously impacted by the LTA.
So, here’s a reminder of why pensions are such a fantastic tool.
1. Income Tax Relief
The government encourages pension saving by giving tax incentives, making tax relief one of the major benefits of saving into a pension. This can help reduce the amount of Income Tax you pay and can be used to help boost your savings for the future.
The amount of tax relief you get usually depends on the rate of income tax you pay. A Basic Rate taxpayer would receive 20% in tax relief on their contributions, for example if you added £800 to your pension, the government would add an extra £200 in tax relief.
If somebody is a higher rate taxpayer, they can potentially get up to 40% tax relief, meaning a £10,000 pension contribution, could cost as little as £6,000. If somebody is an additional rate taxpayer, the tax relief could be up to 45%. The key consideration here is the individual must pay sufficient tax at the higher or additional rate to claim the full 40% or 45% tax relief.
2. Company Pension Contributions
These are an excellent method for business owners to extract money from their business in a tax efficient manner.
Payments made by a business into a pension for an individual are not personally taxable, therefore avoiding Income Tax, National Insurance and Dividend Tax (if payable).
The payments are also considered a legitimate business expense, provided they are solely and exclusively for the purposes of trade (important to check this with an accountant) and will reduce profits, and so the company’s liability to Corporation Tax.
The business can usually also contribute more than the individuals net relevant UK earnings, which is not possible with personal contributions. This is particularly helpful if somebody has not fully utilised their annual allowance in any of the three previous tax years, as the company could potentially make a large contribution into their pension which may not be possible from a personal perspective depending on income levels.
Let’s take a look at an example:
| Pension Contributions | Unused Annual Allowance | |
| 2021/22 | £0 | £40,000 |
| 2022/23 | £0 | £40,000 |
| 2023/24 | £0 | £60,000 |
| 2024/25 | £0 | £60,000 |
| Total | £0 | £200,000 |
For the purposes of this example, we have assumed the individual does not have a reduced annual allowance due to their earnings.
In the above scenario the business owner has unused annual allowance in the current and last three tax years. They have however been a member of a registered pension scheme in the last three tax years.
Therefore, their company may be able to make a pension contribution of up to £200,000 gross, provided the company accountant is satisfied that the size of the contribution is justified.
The company could then receive Corporation Tax relief of up to £50,000 (25% of £200,000). Meanwhile, the business owner extracts £200,000 from his business tax efficiently and builds a fund for his retirement.
3. Tax Efficient Growth
Taxes can have a large impact on investments.
Pensions however are a form of tax efficient investment as income and capital gains within a pension are completely free of tax. This becomes more important when your tax bracket is higher.
In the example below, both investors are additional rate taxpayers and hold portfolios of £500,000 each, which are growing at 3% per annum and produce a dividend yield of 3% per annum, net of ongoing charges. Investor One holds his portfolio within a pension, whilst Investor Two’s portfolio is not held within a tax efficient investment.
We have assumed that current tax bands, tax rates and allowances, such as the dividend allowance remain the same and are applied as required throughout.
| Year | Investor One’s Portfolio value | Investor Two’s Portfolio value |
| 1 | £530,000 | £524,098 |
| 2 | £561,800 | £549,356 |
| 3 | £595,508 | £575,833 |
| 4 | £631,238 | £603,585 |
| 5 | £669,113 | £632,675 |
| 6 | £709,260 | £663,166 |
| 7 | £751,815 | £695,128 |
| 8 | £796,924 | £728,629 |
| 9 | £844,739 | £763,746 |
| 10 | £895,424 | £800,554 |
At the end of year ten we can see that Investor One’s tax efficient pension portfolio is nearly £95,000 greater than Investor Two’s non-tax efficient portfolio.
Furthermore, Investor Two’s portfolio would have large unrealised capital gain, which would be taxable on sale at 20% over their capital gains annual exemption (£3,000).
We would also note that 25% of a withdrawal from a pension is usually tax-free. The balance meanwhile is taxable at the members, marginal rate of Income Tax, in this instance 45%. However, the member may be able to avoid drawing an income whilst an Additional Tate Income Taxpayer and instead draw an income when subject to Basic Rate Income Tax of 20%, for example when they retire.
Nonetheless, in summary, using pensions to hold your investments is one of the best ways to boost your investment returns.
4. Inheritance Tax (IHT) Relief
On death, your pension may be inherited by your named beneficiaries, or your next of kin, provided your pension provider allows this option.
Crucially, your pension fund does not form part of your estate for IHT purposes and may therefore be inherited free of IHT.
This makes pension funds an excellent tool for mitigating potential IHT, as you could, theoretically, pass on the funds held in unused pension money to your loved ones without having to worry about IHT reducing the value by up to 40% depending on your circumstances.
This is also the case if you are now retired and have no relevant UK earnings (which does not include pension income) and your estate faces a potential IHT on your death. If this is the case, you could contribute £2,880 net each year to your pension. We can see the potential IHT benefits of doing this every year for five years in the table below.
| Year | New Investment | Potential IHT avoided |
| 1 | £2,880 | £1,152 |
| 2 | £2,880 | £1,152 |
| 3 | £2,880 | £1,152 |
| 4 | £2,880 | £1,152 |
| 5 | £2,880 | £1,152 |
| Total | £14,400 | £5,760 |
The value of each net contribution of £2,880 would be immediately removed from your estate and would therefore not be liable to IHT on your death.
Each net contribution will also receive basic rate Income Tax Relief at source of £720.
Whilst the above IHT saving may not seem huge, it is important to remember this is based on the minimum you may contribute to a pension each year. Moreover, the potential IHT of £5,760 avoided in the above example could pay for a family holiday for your loved ones, help towards a house deposit for a child, or pay for a grandchild’s first car.
Summary
Pensions are a fantastic tool for investors and given the abolition of the LTA, you may find you are able to contribute to a pension for the first time in many years. In turn, this may mean that you are able to reduce yours or your company’s tax bill, whilst also potentially boosting the overall value of your pot.
However, it is important to remember that pension legislation is complex and must still be considered on a case-by-case basis.
As always, if you have any questions or wish to discuss any of the topics covered, please contact your Financial Planner who will be more than happy to assist.
