Generous Employer Pension? Beware of the hidden tax traps…

Many employers now offer pension contributions as part of their remuneration packages – in fact, following the introduction of Auto Enrolment Pensions in October 2012, you and your employer are obliged to make contributions to a pension scheme, unless you specifically opt out.


For most people there is the opportunity to make combined employer and employee contributions of up to £60,000 (gross, from 6 April 2023) per annum that will benefit from tax relief.  Sometimes it is even possible to contribute more (if you have allowances brought forward).  However, for those that earn in excess of £240,000 up to April 2023 and £260,000 thereafter, the amount that can be contributed without triggering a tax bill is restricted due to the introduction of Tapered Allowances in 2016.


If contributions are being made by your employer, you may have little control about how much is paid in each year.  If the contributions exceed the permitted threshold for your level of earnings, you will be responsible for repaying the extra tax relief, which may give you an unexpected tax bill at the end of the year.


Tapered allowances

Tapered pension allowances were introduced in April 2016, and anyone earning more than a certain threshold of income suffers a reduction in the amount they are allowed to contribute.  This happens at a rate of £1 for every £2 excess income.


These rules take into consideration both “threshold income” which is broadly the same as taxable income plus salary sacrificed benefits less personal pension contributions, and “adjusted income” which is the threshold income plus employer pension contributions.  Until April 2023, if you had threshold income of at least £200,000 AND adjusted income of £240,000 or more, your pension allowances would be tapered for the amount of excess adjusted income. The maximum amount of tapering left allowances of £4,000 under these rules.


From April 2023 the levels of earnings that are affected have increased to £260,000 adjusted income, so fewer people are affected now.  In addition, the maximum tapering has been increased to provide an allowances of no less than £10,000.  Those earning the highest amounts will therefore have marginally more scope for making contributions under the current rules.


Brought forward allowances unused in the last three years can still be used, but only if you were actually a member of a scheme during those years and there was any used balance left. For many this has meant that 2016/17, 2017/18 and 2018/19 allowances were not too small as there may still have been some of the pre 2016 allowances of £40,000 being brought forward and so the effect has only really been felt in 2019/20 and later.


Tax Claw Back

If you are subject to tapering, and if your employer’s remuneration package includes anything more than fairly modest contributions (or you want to make personal contributions in addition to these), there could be a claw back of the automatic tax relief that you are deemed to have received from getting the contribution in the first place.  This will be at a rate of 45%.


When you prepare your tax return you will need to ensure that you declare contributions you make yourself and those made by your employer and you will need to make sure you have a record of previous contributions to ensure that if there are any brought forward allowances available, you can use them.


Depending on the scheme you are part of, personal contributions may need to be grossed up for basic rate tax, and while you may still be eligible for some tax relief, relief on the excess will be withdrawn and needs to be repaid under Self-Assessment.  The clawback then gets added to you tax bill for the year.


So, is it worth letting your employer contribute still?

Unless your employer is providing you with other offers of remuneration then the answer from a tax perspective is probably “yes”.   You are still receiving the benefit of these contributions free of National Insurance, and any growth or gains within the pension will be tax free until you draw on them, making this still quite tax efficient.  However, if your employer is offering other alternatives, you may wish to consider those after taking financial advice about how much you should be putting aside for your retirement.


What next?

For more information about the taxation of pensions, or any other tax query, please contact Michaela Lamb, or a member of the private client tax team.

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