End of year bonuses from work.
How to invest £160k in a single pension contribution
You have slaved all year and hopefully get a nice reward for all that effort
Oh what to do with the extra cash?
Ideally everyone should pay off some of their mortgage and to be frank with most of us being able to pay off 10% a year without penalty, perhaps that should be what every adviser recommends their clients to do.....
But with borrowing rates at historic lows, many are thinking of what investment options their clients should look at for all this extra cash. Some may simply encourage the ISA and there is nothing wrong with that thought but take a step back and consider a more longer term view.......Pensions.
As someone who has managed one of the largest pension schemes in the country I often get asked "are pensions worth investing in?"
I don't always think that they are. They can be restrictive and complicated and are fraught with confusing literature and terms BUT and here are my two reasons to advise people to put their money into them....
- You can gain income tax relief or free money!
- If you have poor financial discipline, they are restrictive until you are 55!
To put it bluntly, you get free money from other people and you can't simply blow it all on what you like, at least not before 55.
So what is Carry Forward all about and why should my clients use it?
Carry forward allows you to utilise unused pension contributions from previous years, in effect to make much larger contributions made up from left over allowances that you were unable to use.
You may remember that we had a combination some years ago of Carry Back and Carry Forward. Carry Back in effect allowed you to treat a current year's contribution as if it had been paid in the previous tax year - if you were a basic rate tax payer in the current tax year but a higher rate one the year before then you would gain more income tax relief by carrying the contribution back to the previous tax year. Sadly we have lost Carry Back
But carry forward allowed the bringing into the current tax year unused contributions. Let us take an example.....
Tax Year Contribution Allowance Contribution Made Contribution Left
2018/2019 £40,000 £20,000 £20,000
2017/2018 £40,000 £15,000 £25,000
2016/2017 £40,000 £10,000 £30,000
2015/2016 £40,000 £0 £40,000
So on the face of it, it appears that this person has unused contribution allowances totalling some £115,000. Therefore this person can make extra contributions to a registered pension of £115,000, right? Well, yes in this simple example that appears to be the case BUT there are some rules from HMRC
- You must fully fund the current tax year before you can consider Carry Forward.
- You must have earnings to support the total contribution that you plan to make
- If you have a limited company then the company can make the full contribution, you need not have the income to support it (only the current year's normal contribution) **
- You can only use the three previous tax years
- You must have some form of pension plan, active, deferred or in payment (also if you have a pension sharing order in payment)
- You must use the previous tax years in reverse order, starting with the furthest back.
** The contribution that your company makes must however pass the "Wholly and exclusively for the purposes of trade" test.
So in theory and assuming that you meet all the above rules, you could in one year make a gross contribution of £160,000 to a registered pension!
This can therefore be a great way for a director to access tax efficient profits form their business, especially when nearing retirement or for that employee that has a share scheme vesting or even a client with a maturing deposit investment or perhaps a cash ISA they have built up......