How much can I put into my retirement fund? - Gareth Shaw

As part of my pay package, I have had a long-term incentive plan in place. It matured this year, and I have netted a significant cash bonus. My pension isn’t as big as I’d like it to be and I would like to put a good chunk of my bonus into a retirement fund. How much can I put in?

'My pension isnt as big as Id like it to be and I would like to put a good chunk of my bonus into a retirement fund'.

Gareth says…

You were reluctant to tell me the exact amount of your bonus, although I do know it is in the high five figures. So, while I’m unable to answer your question completely, I can certainly help you understand your options.

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Contributions to your pension enjoy a significant perk – a top-up from the government in the form of ‘tax relief’ as a way of thanking you for taking responsibility for your future. The amount of tax relief depends on the income tax rate you pay. Basic-rate taxpayers get 20 per cent tax relief; higher-rate taxpayers get 40 per cent and additional-rate taxpayers get 45 per cent. It’s slightly different in Scotland – you’ll either get 20 per cent, 21 per cent, 41 per cent or 46 percent depending on your income.

However, this isn’t limitless. There’s a cap on the amount you can save into a pension each year and earn tax relief, known as the pensions annual allowance. It’s equivalent to 100 per cent of your income, capped at £40,000 a year. This means that if you earn £40,000, you could theoretically put it all into a pension. But if you earned £60,000 and put it all into your pension, you’d pay a tax charge on anything above your annual allowance.

While on the face of things it would seem that you are only able to put a maximum of £40,000 worth of your bonus into your pension, there is a useful loophole in the annual allowance rules – something called ‘carry forward’. This allows you to backfill up to three previous tax years’ worth of unused annual allowance.

This means you’d have what was left from your 2017-18 annual allowance, 2018-19 annual allowance, 2019-20 annual allowance and this year’s annual allowance. As the annual allowance in each of these years was £40,000, that’s a potential £160,000 that can be saved into your pension and have tax relief added to it.

Of course, this comes with some caveats. While you may have a potentially huge amount to invest into your pension with unused allowances, it is still capped by the amount of ‘relevant’ earnings you have in the year you make the contribution. For example, if you want to put £100,000 into your pension, you need to earn £100,000 in that year. Fortunately, this doesn’t apply to employers’ contributions, so if your bonus were pensionable, you would still be able to receive those contributions without exceeding your pension contribution limits.

Given that the addition to your bonus to your regular salary puts your income for the year, as you tell me, in the ‘low six figures’, it looks like this is something you could take advantage of. However, there is something you need to watch out for, as annual allowances for high earners face some restrictions.

If you previously earned more than £110,000 and your ‘adjusted income’ – the combination of all of your taxable income, plus your employer pension contributions - was more than £150,000, your annual allowance would start to fall.

This is known as the ‘tapered annual allowance’. If your total adjusted income was between £150,000 and £210,000, you’d lose £1 of annual allowance (starting at £40,000) for every £2 of adjusted income until your annual allowance fell to a minimum of £10,000 a year.

This year, these thresholds were increased by £90,000 - in April, both the threshold and adjusted incomes rose by £90,000 to £200,000 and £240,000 respectively.

For those with total income over £300,000, the annual allowance gradually falls from £10,000 to £4,000 meaning that it is £4,000 only for anybody earning in excess of £312,000.

Without knowing the figures, I don’t know if this applies to you. But I do suggest taking professional financial advice.

There are lots of other factors that can impact your use of carry forward, and indeed whether or not you are affected by the tapered allowance following your bonus. A professional adviser can help navigate you through this, so that you don’t end up with an unnecessary tax bill.

Gareth is the Head of Money at which.co.uk

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