Time is Money: Why Higher Earners Should Use Their Annual Allowance Before It's Too Late

Over the years, we have come across many higher earners who are not taking full advantage of their pension allowances despite having the means to do so.

This is particularly common with younger individuals who often feel that retirement is a long way off and they have plenty of time to plan for it.?

However, as their salaries increase, the window of opportunity to utilise these precious allowances can quickly disappear, along with the potential benefits of contributing early to a pension.

Furthermore, as one gets older, more of your salary can easily be used up by mortgage costs, school fees, and the general increase in living expenses.

Tax Efficiency of Pension Contributions

In addition to the tax-free growth, compounding returns, and tax-privileged status on death, arguably the main immediate benefit to higher earners is the significant tax relief they receive on making a contribution in the first place.

As an example, someone with surplus cash and annual earnings of ￡240,000 would have the scope to make a pension contribution of at least ￡40,000.

If they wanted to make a personal contribution of ￡40,000 (i.e. directly from their savings), they would only need to contribute ￡32,000 of their surplus cash, with ￡8,000 of basic rate tax relief subsequently added directly to their pension by the government.

Moreover, as an additional rate taxpayer, they would then receive a further ￡10,000 of tax relief through their self-assessment tax return.

In summary, it would have effectively only cost them ￡22,000 to put ￡40,000 into their pension.

Reducing Allowances

However, due to the taper annual allowance rules, if someone earns over ￡240,000 their annual allowance (the amount that can be saved into a pension each tax year and receive tax relief) will be reduced by ￡1 for every ￡2 of income over ￡240,000 down from ￡40,000 until it reaches just ￡4,000.

So, as their earnings increase, their annual allowance and ability to benefit from pension contributions decreases.?

We often find that, in response to this, higher earners have significantly reduced or stopped making contributions altogether to avoid falling foul of these rules.

Unfortunately, this is not always the best option as the current pension rules also allow you to utilise unused annual allowance from up to three previous tax years. Therefore, in some instances there could still be scope to make significant contributions.

In fact, there can even be scenarios where making the appropriate pension contribution can recover some, if not all, of an individual’s annual allowance and allow them to make an even greater pension contribution than they originally thought. However, the calculations for this are too complex to be illustrated easily and therefore outside the scope of this article.

Conclusion

For higher earners the window of opportunity to utilise pension allowances can be fleeting, particularly if someone enjoys sudden increases in their earnings over a short period. This is why it is so important to make use of these allowances when you can because, as the saying goes, “once it's gone, it's gone.”

As with any tax planning, your wider situation needs to be taken into account when considering pension contributions. This is a complex area of tax planning, and we would always recommend seeking professional advice.

If you are a higher earner who would like help maximising your allowances, please reach out to us to see if we can help.

Taylor Money Ltd is authorised and regulated by the Financial Conduct Authority. The information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested. Tax rules may change and the value of tax reliefs depends on your individual circumstances.