A guide to understanding your pension allowances

Wednesday, 28 November 2012 10:40

You need to monitor your SIPP investments

You need to monitor your SIPP investments

If you have decided that a Self Invested Personal Pension (SIPP) is your best option in terms of retirement planning, you need to make sure you fully understand the rules relating to taxation and pension allowances – and are aware of the recent changes.

In April 2012, new legislation came into force that made a number of changes to the UK's pension system, which impacts both employees and employers – but more about that in a minute.

The main reason to opt for a SIPP, rather than another type of personal pension, is to have greater control over how your pension pot is invested. It therefore stands to reason that, if this is your retirement planning ethos, you'll also want to understand how to make the most of your pension allowances.

Of course, you should always remember that the value of any investments you make as part of a SIPP can fall as well as rise, which means any income from them is not guaranteed. As a result, you need to be prepared to lose all or part of your investment when you put your money into a SIPP.

You should also bear in mind that past performance is not an indication of future performance when you are making your SIPP investment decisions.

A breakdown of personal pension allowances

For tax purposes, SIPPs are treated in the same way as other personal pension plans. This means the lifetime and annual allowance – the amount you can pay into a SIPP before you are charged tax – is what you would pay in any other scheme.

From April 2012, the lifetime allowance for pensions was revised downwards from £1.8 million to £1.5 million. So, if the value of your pension (or pensions if you have more than one) totals more than this, you will be liable to pay tax on any funds above this threshold.

The percentage of tax you are charged will vary depending on whether you take the money over the lifetime allowance as a lump sum or if you receive it as income. In the case of the former, your tax liability will be 55 per cent, and for the latter it will be 25 per cent.

Annual contributions, meanwhile, are limited to £50,000 (gross) with the ability to carry forward unused allowance from the previous three tax years, and anything over this amount will be subject to the marginal rate of income tax. These cover payments made by an individual, as well as those added by any other person or organisation on behalf of that individual.

Of course, as demonstrated by the changes to the way in which pensions operate in the last Budget, you should be prepared for the fact that the levels and bases of taxation may change in the future.

You should also be aware that the extent and value of any SIPP tax advantages or benefits will vary according to an individual's circumstances.

Tax relief on SIPPs

There are various forms of tax relief relating to pensions, but two in particular are important to understand if you are taking out a SIPP pension – the maximum relievable personal contribution and the maximum pension commencement lump sum.

We'll start with the maximum tax relievable personal contribution, which is the value of contributions on which you can claim tax relief if you have no UK earnings, or your earnings do not exceed a specific threshold, which, for personal pensions, currently stands at £3,600 annually.

What this means in real terms is that, if you pay in up to this amount and are charged your income tax rate on your contributions, you are entitled to claim this back from HMRC and add it to your pension pot.

The maximum pension commencement lump sum, meanwhile, refers to the highest percentage that you are allowed to access as a lump sum when you become eligible to draw your pension. For SIPPs, this is currently 25 per cent of the pension benefit value. The exact amount you can contribute, and the tax relief you can receive, will depend on your circumstances and are subject to change by the government. You should also remember that, in general, the money from your pension will only be accessible from the age of 55.

Obviously, SIPPs are not the only pensions available and, if now or in the future, you have the option of joining an employer's occupational or contributing scheme, you should consider doing so.



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