If you have a pension problem, feel free to write to the Pensions Doctor at [email protected]. The columns are published weekly.
Dear Becky,
I absolutely adore reading your column. I wanted to express my deepest gratitude for all the invaluable insights you provide.
After reading a related story, I have a query about pension contributions.
A few years back, I faced a severe illness that compelled me to leave my job in a partnership company. Due to this incident, I became unable to work and was granted a disability pension, which amounted to approximately one-fifth of my previous salary. This happened several years before the standard retirement age.
Subsequently, I was informed that I could only contribute £3,600 per year to my pension. I verified this with HMRC, but the rules seemed unclear. After discussing the matter with my company, it was agreed that £3,600 was indeed the maximum contribution I could make to a pension.
Considering the illness was not my fault, this restriction appears incredibly unjust. Is this truly the case?
Do you possess any insights into this matter?
Thank you very much and best regards, Anonymous
Dear reader,
HM Revenue & Customs does not impose limits on the amount of contributions an individual can make into a registered pension scheme. However, there are limitations on the contributions that qualify for pension tax relief.
Tax relief can be received on contributions up to £3,600 (equivalent to £2,880 plus the tax relief) or up to the relevant UK earnings that are taxable for that tax year, whichever amount is greater.
Since you are no longer employed and earning an income, the maximum amount you can contribute to a pension while still receiving tax relief is £3,600.
This rule applies universally, irrespective of personal circumstances such as disability, illness, or inability to work and earn an income.
Pension income does not fall within the definition of relevant UK earnings. Thus, when an individual’s sole income is derived from pensions, the tax-relievable contributions are limited to £3,600.
There are additional limits on pension contributions.
Pension savings are evaluated against the annual allowance, currently set at £60,000. The “tapered” annual allowance comes into effect when an individual’s “adjusted income” exceeds £260,000 per year, resulting in a reduction of £1 for every £2 earned over £260,000.
If an individual has accessed their pension savings through a “money purchase arrangement,” they may be subject to the money purchase annual allowance (MPAA), currently set at £10,000. This limit was raised from £4,000 this year to provide individuals who access their pensions but wish to resume contributions more flexibility. This aligns with the government’s initiative to encourage individuals over 50 to return to work.
You may wonder why there are restrictions on pension contributions eligible for tax relief?
The purpose of tax relief is to incentivize retirement savings and offset the tax liability arising from earnings. Consequently, limitations help prevent planned “recycling” of pension funds among individuals who can access and contribute to their pensions. “Recycling” involves withdrawing funds from a pension and reinvesting them to claim tax relief at the individual’s marginal income tax rate. With tax relief ranging from 20% for basic rate taxpayers to 40% for higher rate taxpayers and 45% for additional rate taxpayers, the potential gains from recycling are significant.
HMRC aims to prevent such practices and imposes severe penalties on those who breach the recycling rules. However, there are circumstances within certain parameters where it is permissible. For instance, individuals may return to work to increase their pension pot or decide to contribute part of an inheritance to a pension.
If you were to resume some form of work resulting in increased earnings, you could potentially contribute more to your pension. Alternatively, you could consider contributing more to your pension currently, as it may still benefit from investment growth, albeit without tax relief beyond the £3,600 limit.
Additionally, you may want to explore using an Isa for further savings, as income withdrawn from an Isa is tax-free. Consequently, Isas could be a viable option for your consideration.
If you have any pension-related issues, feel free to write to the Pensions Doctor at [email protected]. The columns are published weekly.
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