Successive governments may have held off making cuts to the headline tax break for retirement - we’ll hear tomorrow if Philip Hammond follows suit - but that doesn’t mean pension rules aren’t changing.
Tax relief on the money you pay into a pension remains, for the time being, linked to the income tax you pay. So the highest earners are offered the largest potential benefit.
Other rules governing what can be paid in, however, have been getting tighter for years. The limits of what can be paid in with tax relief, both on an annual and lifetime basis, have been falling - dramatically so for the highest earners.
2017 will see the system once again get a little bit less generous. That’s because the amount permitted using “carry forward” will fall after April 5. Combined with other recent changes, this could leave many retirees sleepwalking into a painful tax charge.
Why carry forward matters
As with so much to do with pensions, carry forward is cumbersome to explain and can be difficult for anyone other than financial professionals to understand. Nonetheless, it is widely used and can be extremely useful for those readying themselves for retirement.
In the simplest terms, carry forward allows you to contribute more to a pension than you would normally be allowed to in any one year. That becomes a valuable option when you’re getting close to retirement and want to maximise the help on offer before you stop work and your income falls.
Here’s how it works. We all have an annual allowance for pension contributions. Contribute more and there is a tax charge to pay. The annual allowance now sits at £40,000 for most people.
Only a few people make annual pension contributions at that level, so most won’t use all their allowance. Carry forward allows you to take unused allowance from the three previous years, add it to your annual allowance for the current year and give your pension a bumper injection.
Quite obviously you’ll need the money to do this in the first place, but the years before retirement are often exactly when such large sums are available, thanks to typically higher earnings, lower costs once the mortgage has been paid and children have become financially independent and possible windfalls from inheritance.
There are rules to bear in mind, including that the amount contributed using carry forward must not exceed your total earnings for the year.
Why the window is closing
The potential for using carry forward is reducing this year because, after April, the 2013/14 tax year will fall out of the three-year period. That’s important because the annual allowance in 2013/14 was £50,000. After that it fell to £40,000, its current level.
It means that, whatever unused allowance you have available for carry forward now, it’ll be £10,000 less in 12 months’ time.
And things will get worse in the coming years. A special arrangement existed in the 2015/16 tax year that meant a higher annual allowance was in place - potentially as high as £80,000 - as a transitional measure. That means another significant closing of the window will arrive in 2019, when that higher allowance falls away.
Why high earners face a double squeeze
Carry forward may prove particularly valuable this year for those with high salaries. That’s because anyone whose annual “adjusted” income is more than £150,000, and annual “threshold” income is more than £110,000, will have already seen their annual allowance shrink.
Threshold income includes your income from all sources minus pension contributions you’ve made, while adjusted income is all your taxable income plus any pension contributions made to a workplace pension by you and your employer.
For every £2 that your adjusted income exceeds £150,000, your annual allowance reduces by £1.The maximum reduction to the annual allowance is £30,000, which means it reduces to £10,000 when your adjusted income hits £210,000.
The annual allowance “taper”, in place for the first time this year, creates a greater chance that savers will stray beyond the permitted limit. For those who find themselves in this position, carry forward could act as a valuable safety valve.
Understanding its limits, which are getting tighter, will become crucial in the years ahead.
The value of investments and the income from them can go down as well as up, so you may not get back what you invest. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Eligibility to invest into a pension and the value of tax savings depends on personal circumstances and all tax rules may change. You will not normally be able to access money held in a pension till the age of 55. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.