How to use carry forward to make big pension payments

Faith Archer

by , Personal Finance Journalist and Blogger

at Much More With Less

01 Apr 2022 /  

Man on his phone, walking and carrying a suitcase.

This year, faced with rising inflation, I’ve ploughed more into my pension than ever before. By taking advantage of ‘carry forward’ rules, I’ve been able to pay in more than my £40,000 annual allowance and still scoop up tax relief.

If you want to shovel more into your pension, get your skates on before the current tax year ends on 5 April, and before one year of your allowance disappears.

How carry forward works

Here’s the deal. Every year, most taxpayers are allowed to pay up to 100% of their earnings into a pension, capped at a maximum of £40,000 a year, and get a boost from tax relief.

(I say ‘most people’, because if your income plus pension contributions exceeds £240,000 a year, the tax man starts chipping away at your personal allowance, reducing it by £1 for every £2 over until the allowance dwindles to £4,000).

But if you didn’t pay in your full whack of personal allowance in previous years, you can ‘carry forward’ unused allowance from up to three previous years. That’s a maximum of £160,000, in theory! However, ‘carry forward’ is limited by the amount you earn that year. If, say, you earn £70,000 during the tax year, you can’t pay more than that into your pension, no matter how much unused personal allowance you racked up in previous years. There’s also small print about actually being a member of a pension scheme during the previous years.

Let’s be clear: carry forward is only useful if you are lucky enough to earn more than £40,000 a year and lucky enough to have a big lump sum to pay into a pension. But if so, carry forward can be really useful for example if you’ve had a big bonus at work, received an inheritance or had a particularly good year with your own business.

More about pension carry forward rules.

Why I’m keen to pay more into my pension

Turns out I have more reason than I expected to plough more into my pension, rather than spending up a storm.

Afford to retire

The primary reason for pension saving is to fund a more comfortable retirement. I spent a week trying to live on the £179.60 of the full new State Pension and it was not fun. By beefing up my pension pot, I’m hoping to enjoy retirement with fewer money worries.

Plug childcare gaps

I chose not to go back to my office job after maternity leave, but went freelance instead. This meant I could spend more time with my children and didn’t have the eye-watering expense of full-time nursery fees - but it also meant I wasn’t earning enough to make mega pension contributions. Now I’m earning more, I’m keen to narrow my own gender pension gap.

Bridge the self-employment gap

As I’m self-employed, I don’t have an employer to contribute to my retirement savings. It all falls on my shoulders. Now that my children are both at secondary school, and my work has ramped up, I can afford to plough more into my pension.

Maintain my own income

I may be happily married, but I’m keen to have my own pension, rather than relying on my husband’s retirement savings to fund my every whim. A man is not a financial plan.

Beat inflation, now and in future

Faced with rising inflation, I’d far rather move spare money into the stock market, in the hope of higher returns, rather than seeing the value of my cash eaten away in a savings account. Rising inflation also means I reckon I need to stash more in my pension to cover the higher costs when I stop working.

Scoop up free money

By investing via a pension rather than an individual savings account (ISA), I automatically get 25p added to every £1 in basic rate tax relief, so it’s off to a great start!

Cut my tax bill

Plus, as a higher-rate taxpayer, I can claim extra tax relief on my Self-Assessment tax return, and cut my tax bill.

Not long to wait

Also: old.

As I’m now 50, I have the peace of mind that I don’t have to wait too long before I can whip money out again, if I really need it. I’ll be able to withdraw cash from my pension from the age of 55, although that age limit is rising to 57 from 2028. So long as I keep any withdrawals below the 25% tax-free lump sum, it shouldn’t prevent me from making more pension contributions afterwards.

Escape inheritance tax

But if my husband and I go under a bus tomorrow, we also know any money in our pensions can go to our kids without being hit by 40% inheritance tax (IHT). Soaring property prices have pushed us above the tax-free thresholds, and into the firing line - but money in pensions is protected from IHT.

Calculating carry forward

Brace yourself for the calculations if you want to take advantage of carry forward.

I’ve had to track down how much I’ve paid into my defined contribution pensions, work out my unused annual allowance, compare it to my earnings in the current tax year, and calculate how much I could add before the tax top up.

Current earnings

As I can’t pay more into my pension than my earnings in the current tax year, I figured that was a good place to start. If you earn less than £40,000 a year, for example, you don’t have to faff around with carry forward as you’re not allowed to pay in more than the annual pension allowance anyway.

If you earn say £70,000, you can contribute up to £40,000 as your maximum annual allowance, but only carry forward a maximum of £30,000 from unused allowances in previous years.

As I’m self-employed, I couldn’t just check my payslips or ask HR what I’d earned between 6 April last year and 5 April the next. Instead, I had to work out my profits, by totting up my turnover and deducting allowable expenses.

Pension payments

Next, I checked what I’d already paid into pensions since 6 April last year, and in the three previous tax years. Remember that the £40,000 annual allowance includes not just your own pension contributions that leave your bank account or pay packet, but also any employer contributions and basic rate tax relief added on top. If you pay into pensions anywhere else – at work or in other private pensions – you’ll need to add in those contributions too.

Don’t forget any future contributions that will hit your pension account before the tax year ends on 5 April, for example from a regular Direct Debit or from salary deductions. In practice, checking my pension payments via the PensionBee app was easy – click on ‘Funds’ at the bottom of the screen, then ‘Add and manage contributions’, and it shows the total contributions by tax year, including the tax top ups. I tracked down my total contributions in previous years from my tax returns, but as an employee you could also find it on your P60s.

Unused allowance

To discover my unused allowance, I worked out the gap between my total pension contributions each year and the £40,000 allowance.

Say for example, you’ve stashed £12,000 in your pension so far this year including tax relief, but only £10,000, £8,000 and £5,000 respectively in the previous three years. The table below shows the unused allowance each year, and total across all four tax years.

Tax year Pension contribution Annual Allowance Unused allowance that year
2021/22 £12,000 £40,000 £28,000
2020/21 £10,000 £40,000 £30,000
2019/20 £8,000 £40,000 £32,000
2018/19 £5,000 £40,000 £35,000
Total £125,000

For peace of mind, there’s even a handy dandy calculator on the government website, to check if you have unused annual allowance.

With carry forward, you first use your allowance from the current tax year (eg 2021/22) and then go back three years and start with any unused allowance from that year (eg 2018/19), then move forward to the next one (eg 2019/20) followed by the most recent (eg 2020/21).

Potential contribution

Lacking a six-figure salary and a six-figure lump sum, I focused more on how much extra I could add to my contributions in the current tax year to match my earnings, then checked I definitely had enough unused allowance to cover anything over £40,000.

So for example, if you earn £70,000 a year, and have already paid £12,000 into a pension, you could potentially pay another £58,000 into your pension. If you’ve already contributed £12,000, you have £28,000 left out of the current year’s £40,000 annual allowance.

That leaves a maximum of £30,000 to be covered by carry forward (£58,000 gap less 28,000 from the current year’s allowance), so you need to check you have at least that much in unused annual allowance stretching back over the last three tax years.

The last step is to work out how much to transfer into your pension. You can’t just bung in £58,000 (even if you had that amount), because basic rate tax relief is automatically added on top. In practice, you need to add 80%, which in this example works out as £46,400 (80% x £58,000).

Practical tips for carry forward

After taking advantage of carry forward, here are my top tips:

  • Remember you can’t contribute more than your earnings in the current tax year, no matter how much unused pension allowance you have
  • Don’t count investment income, savings interest, buy-to-let rental income and dividends when working out your earnings
  • Allow for the tax relief that will be added on top, when calculating your contributions. If you want to add £10,000 in total, for example, you only need to pay in £8,000
  • Double check the details when contributing by internet banking - the sort code, bank account number and any reference such as your pension account number. If it’s a personal pension and you’ve made contributions beforehand, you should be fine choosing an existing payee
  • Consider making a small payment first to check it definitely ends up in the right place, then paying in a larger sum afterwards
  • Don’t leave pension contributions to the last minute. If you want contributions to be counted in the tax year ending 5 April, do the transfer several days beforehand, to make sure it’s credited before the deadline.

*Faith Archer is a Personal Finance Journalist and Money Blogger at Much More With Less.

Risk warning: As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

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