Top 5 pension considerations for directors and executives
- Maximising your income potential involves fully utilising the tax reliefs and allowances at your disposal. Talking to a financial adviser can ensure you’re getting the most out of your money.
- In 2023, lifetime allowance penal tax charges were eliminated, and as of April 2024, the lifetime allowance will be entirely abolished and replaced by allowances that only apply to tax-free lump sum payments.
- The pension annual allowance was increased to £60,000 in 2023, potentially providing more opportunities for savings.
As a high-earning executive, it’s essential to ensure your retirement planning is as efficient as possible. Maximising pension contributions can provide substantial tax relief, particularly if you’re in the top tax bracket. However, as your pension fund grows, it’s equally important to explore the full range of reliefs and allowances available to you.
The removal of several pension limitations in the 2023 Spring Budget generally broadens your opportunities. Given these changes, seeking professional financial advice is key to helping you make informed decisions tailored to your specific needs and circumstances.
However, there are key restrictions to keep in mind. The tapered annual allowance affects individuals earning over £200,000, and you may also face Capital Gains Tax on earnings from benefits like shares. A financial adviser can guide you through these intricate rules.
Here are some critical factors you should consider:
- Pension allowances
The scrapping of the pension lifetime allowance (LTA) charge, which was announced in the Spring Budget 2023, eliminates the penal tax charges previously in place. Although the LTA itself will no longer exist from April 2024, certain restrictions remain, including the limit on the maximum tax-free lump sum you can withdraw from your pension. For most people, this will be capped at £268,275, no matter the size of their pension pot, though this can vary. Any amount withdrawn above this tax-free limit will be subject to Income Tax, potentially up to 45% on the income drawn, especially if you have additional income sources.
Given this change, your first consideration should be whether to resume pension contributions if you had previously stopped them upon reaching the LTA cap.
Due to the tax implications of pensions, it’s also important to explore alternative funding options for retirement, such as ISAs (see below).
- The tapered annual allowance
Many high earners won’t fully benefit from the 2023 increase in the pension annual allowance – from £40,000 to £60,000 – as those earning over £200,000 a year could be affected by the tapered annual allowance.
This taper applies if your ‘threshold income’ exceeds £200,000 and your ‘adjusted income’ is over £260,000. Calculating the exact figures can be tricky. In simple terms, the £60,000 annual allowance is reduced by £1 for every £2 of adjusted income above £260,000. If you’re someone who this may affect, we recommend speaking to an adviser.
The tapering process stops at £360,000 of adjusted income, meaning that even with a higher income, you’ll still have an annual allowance of £10,000. Previously, the minimum allowance was just £4,000.
While £10,000 may not seem significant to a high earner, it’s still beneficial to contribute and take advantage of the associated tax relief.
Additionally, if you have a substantial pension pot but now earn less than £200,000 – perhaps due to downshifting later in life – you might still have the opportunity to fully utilise your annual allowance. Remember, although the annual allowance is £60,000, tax relief is only available on 100% of your earnings or £3,600, whichever is higher.
- A cash or shares bonus
If you’re expecting a bonus, it’s worth considering the form you’ll receive it in – whether as cash or shares – if you have the choice. If you receive it as cash, you may have the option to pay it directly into your pension. This allows you to benefit from Income Tax relief at 45% if you’re an additional rate taxpayer, with tax relief above the basic rate reclaimed through your tax return. In some cases, you can even pay it into your pension before being taxed, which not only simplifies the process but also lets you save on National Insurance contributions.
If your bonus comes in the form of shares, typically you’ll need to hold them for three years before gaining full ownership rights. After this period, you can either sell or transfer them into a tax-efficient wrapper. The bonus becomes taxable once the shares belong to you, and your employer will usually offer options on how to settle the tax and National Insurance due at that time. Once the shares are yours, any gains from their sale will be subject to Capital Gains Tax (CGT), but even during the three-year holding period, you’re likely eligible for dividends. These dividends are subject to tax if they exceed the dividend allowance, which is set at £500 for the 2024/25 tax year.
But, if you’ve got shares of your company through a Sharesave or SAYE scheme, you’ve purchased them using already-taxed income. If you have unused ISA allowance, you can move these shares into an ISA, where they’ll be free from CGT and any future dividends will be tax-free as well. Alternatively, you can hold onto the shares and pay CGT when you eventually sell them. Dividends will be taxed at the dividend rate, which stands at 39.35% for additional rate taxpayers, assuming you’ve already used up your dividend allowance.
The key is to make sure you’re maximising all available allowances, which often involves shifting assets between tax wrappers at the right time. Seeking holistic advice on your assets is the best way to achieve this.
- Flexibility from ISAs
Although the annual ISA limit remains at £20,000 per tax year – likely a small portion of the total amount you may want to invest – it’s still a valuable opportunity.
The main benefit of ISAs is the flexibility they offer, with no restrictions on when or how much you can withdraw. For instance, if you need to make a significant purchase before reaching the age when you can access your pension (currently 55, rising to 57 in 2028), you won’t have to worry about incurring tax on the withdrawals.
Incorporating ISA savings alongside your pension in retirement can also provide greater financial flexibility. For example, if you require a lump sum but wish to avoid triggering a tax charge, ISAs offer a tax-efficient solution.
- Accessing your funds in retirement
When planning how to access your funds in later life, it’s important to utilise all available tax allowances effectively; this is known as an ‘all-assets approach’ to retirement.
This strategy involves carefully selecting which accounts to draw from and when. For instance, withdrawing from an ISA, which provides tax-free withdrawals, in combination with tax-free cash and taxable income from a pension can result in greater net income by reducing your overall tax burden and potentially keeping you in a lower tax bracket.
To benefit from this approach, you must ensure that your funds are distributed across various tax wrappers well in advance. Proper planning is essential so you can implement this approach effectively when you reach retirement.
Many people fail to think about this until it’s too late, resulting in assets being locked in less tax-efficient wrappers. Therefore, continuous and proactive financial advice is key. Don’t hesitate to seek expert guidance at any stage.
The value of an Investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief generally depends on individual circumstances.