What can you do if you’ve used up your pensions allowance?

Even so, he increased the annual pensions allowance from £40,000 to £60,000 in his March 2023 budget. He also removed the £1,073,100 lifetime allowance, meaning we can now contribute an unlimited amount into a pension during our lifetime. So people able to save more than £60,000 a year for their retirement may need to consider other tax-efficient opportunities.

I will begin by briefly outlining what the pensions allowances currently are. But let me first state that tax relief on your pension contributions is provided at your marginal income tax rate and growth in the value of your pension fund is tax-free. The marginal rate refers to the highest rate of income tax applying to your income after deducting all of your personal allowances and tax reliefs.

You can normally invest up to £60,000 a year tax-efficiently into a pension (including any employer contributions). But you can make tax-efficient pension contributions above the annual allowance if you haven’t contributed the maximum amount to your pensions in the previous three years. This arrangement is known as carry forward and the relief is based on your earnings in the current tax year.

Pension contributions are linked to your earnings. The maximum amount you can typically invest into your pension is the lower of your annual earnings and the £60,000 annual limit.

If you earn more than £200,000 annually, then the maximum level of your tax efficient pension contributions could reduce. Our Tapered pension allowance for high earners article has more information on this.

Let’s suppose you have exceeded your annual allowance. In this case, your first port of call for tax-efficient investing could be ISAs, which I consider to be a ‘bread and butter’ tax allowance. A key benefit of pensions is that the money you initially invest in a pension can be free of tax. On the flipside, when you come to draw on your pension, that income can then be subject to tax (over and above taking 25 percent of the pension pot value as a tax-free lump sum, although this 25 percent tax-free allowance is capped at £268,275).

With ISAs it’s the other way around. In other words, you may already have paid taxes on the money you invest in an ISA, but you are not liable for tax on income or capital gains arising from your ISA investments if and when you come to encash them.

In this article I will just consider stocks and shares ISAs, which are free of capital gains tax and income tax. Stocks and shares ISAs can contain company shares, corporate bonds, government bonds and investment funds and unit trusts. If you’re aged 18 and above, you can invest up to £20,000 annually in a stocks and shares ISA (less any amount you’ve paid into a cash ISA in that same tax year). And the ISA does not terminate when the tax year ends, but stays active for as long as the ISA remains invested.

Over time, regular £20,000 annual ISA investments have the potential to build up, however, as with all investments, they come with risk. A couple each investing £20,000 in an ISA could (excluding any potential investment growth) hold £200,000 after five years and £400,000 after ten years. Since many of us have investment horizons of more than ten years, there is scope for people to end up with significant ISA holdings.

When it comes to clients who have used up both their pensions and their ISA allowances, I often consider general investment accounts (GIAs) and onshore or offshore bonds. But whether and how any of these are used depends on personal circumstances.

GIAs are investment accounts held outside a pension or ISA. They are subject to tax, so you can be liable for CGT on any capital gains made above your CGT allowances. You could also be liable for income tax on any income received and for higher or additional tax on dividend payouts above your dividend allowances. Even so, GIAs can be a good way to make use of these allowances, although CGT and dividend tax allowances are reducing significantly in the next two tax years.

Crucially, the CGT rate on GIAs for basic rate taxpayers is 10 per cent, significantly lower than the 20 per cent rate for higher rate taxpayers. Similarly, the dividend tax rate is just 8.75 per cent at the basic rate, but a significantly higher 33.75 per cent at the higher rate and 39.35 per cent at the additional rate. Consequently, GIAs can be particularly suited to basic rate taxpayers who can benefit from these lower tax rates.

In contrast, higher and additional rate taxpayers could benefit from investing in offshore or onshore bonds. These bonds can hold a wide range of assets, including shares (equities), bonds and property. They are not subject to CGT but are subject to income tax. Even so, you can withdraw 5 per cent of the original capital each year without facing any immediate tax. This arrangement of tax deferral is cumulative, so if you don’t withdraw the annual 5 per cent, then it will build up, enabling you to withdraw more than 5 per cent later on. In addition, these bonds can be particularly tax efficient if encashed at a future date by someone such as a family member who is a nil or lower rate tax payer. And they can play a useful role in estate and inheritance tax planning.

If you’ve fully used up your pensions allowances, ISA allowances and other tax allowances and you have a tax bill, then venture capital trusts (VCTs) might be a suitable option. VCTs are listed on the stock exchange with a remit to invest in small, unquoted, higher risk companies. These companies must generally have less than 250 employees and must generally receive their first VCT financing within seven years of their first commercial sale.

VCTs offer 30 per cent tax relief for investors who subscribe for new shares prior to the VCT listing, as long as the VCT is held for five years. So a £20,000 investment in a VCT could reduce your income tax bill by £6,000. Indeed a VCT investment can sometimes wipe out an entire income tax bill. Moreover, VCTs are not liable for income tax on dividends or for CGT.

In contrast, investors who acquire their VCT shares second-hand (from the stock market or by inheritance) don’t receive the initial 30 per cent tax relief, which can make them less useful for tax planning. But second-hand VCT shares do still benefit from the exemption from income tax on dividends and from CGT.

VCTs are higher risk investments, reflecting the higher risk nature of the companies they hold. But they invest in a range of companies, so investors do benefit from a degree of diversification. At present, there are around 80 VCTs on the stock market, invested in around 1,100 companies.(1)

VCTs have the potential to offer financial planning benefits to clients who are willing to accept the higher risks and who have the financial capacity to withstand potential investment losses.

Enterprise investment scheme (EIS) investments also offer 30 per cent tax relief at subscription and are considered even higher risk than VCTs, but they do come with even greater tax incentives. For example, by investing in an EIS you could potentially defer CGT liabilities incurred from selling other investments or a second home. Moreover, unlike VCTs, EISs can be free of inheritance tax, as long as they are held for at least two years.

VCT investments are limited to a total of £200,000, but you can generally invest up to £1 million in an EIS. But EISs are not listed on the main stock market (although some are quoted on London’s AIM market) and so can be harder to sell. Their limited tradability, coupled with their high-risk characteristics, make EISs inappropriate for many investors.

There are, then, a range of options for people who have maxed out their pensions allowances to manage their finances tax-efficiently. But finding the right options for you involves understanding what you’re trying to achieve and what your circumstances are, which will be different for each individual. A good financial adviser can work with you to find the tax-efficient investments that meet your unique requirements.

Financial Times, ‘Venture capital trusts: overpriced or time to buy?’, 2 December 2022.

This article is for information purposes only. It is not intended as investment advice.

The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits which isn’t guaranteed and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.

The value of investments and pensions and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.

Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.

Cash savings and investments are protected to the value of £85,000 per person per institution by the Financial Services Compensation Scheme (FSCS). However the value of investments may fall as well as rise.

Any views expressed are our in-house views as at the time of publishing.

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