1st December 2022
general
Relief on Your Contributions
If you pay into your pension personally, you will automatically receive tax relief. For every £80 you pay in, HMRC will credit £20 directly to your pension. Your gross contributions (your payment plus tax relief) are capped at the higher of £3,600 per year and your relevant UK earnings.
If you are a higher or additional rate taxpayer, you can also claim back further tax relief through self-assessment. This means that a gross pension contribution of £1,000 will only cost you £600 (or £550 for additional rate taxpayers) from net income.
If you own a limited company, you can also make pension contributions through the business. Pension contributions are normally an allowable business expense (subject to approval by the local inspector of taxes), and can reduce your corporation tax bill.
Your total contributions, either paid personally or through your company, are capped by the annual allowance of £40,000 per year. However, if you have not fully used up your annual allowance, you can carry it forward by up to three tax years. This allows for larger one-off contributions.
Remember, personal contributions are still capped by earnings, so this option is only effective for those earning over £40,000 or paying contributions through a company.
Contributing Through Your Employer
Opting into a workplace pension can be an excellent way of boosting your retirement benefits. Your employer will normally match your contributions up to a certain limit.
When contributions are deducted through salary sacrifice, you only pay tax on your earnings minus the contributions. This simplifies matters, especially if you are a higher or additional rate taxpayer, as you don’t need to claim back tax relief.
As salary sacrifice effectively reduces your income, you and your employer can also save on National Insurance. Providing your earnings are above the Lower Earnings Limit (£6,396 per year), you will still build up entitlement to the State Pension and other benefits.
Increasing your contributions can be a good idea, but you need to make sure that your reduced earnings remain above minimum wage.
Tax-Efficient Investments
Another advantage of pensions over other investments is that you don’t pay tax on your investment funds.
When you invest, your assets will generate interest and/or dividends. When this income accumulates in a pension, it is not taxable.
Pension investments are also free of capital gains tax, which means you can switch your funds or change pension providers without worrying about CGT.
What Happens When You Take Benefits?
In most cases, you can withdraw a 25% tax-free lump sum from your pension. Some older occupational schemes offer an even higher amount.
It may suit you to withdraw the full lump sum, as this can help to clear a mortgage, make gifts to family, take the holiday of a lifetime, or make home improvements before settling into retirement.
Alternatively, you can take the tax-free cash over time to supplement your income. Assuming the fund continues to grow, this can actually increase the amount of tax-free cash you receive.
The remaining 75% of your pot will be taxed at your normal rate as and when you withdraw it. As pensions are flexible, you can control the amount you take depending on your tax position. For example, you might take more in the early years and reduce it when your State Pension comes into payment. It could be efficient to withdraw pension income up to the level of your personal allowance (currently £12,570 per year) and supplement this with cash and investments.
Passing on Your Pension
If you have significant other assets or income, you may find that leaving your pension invested indefinitely is the most tax-efficient option. Your pot will continue to benefit from tax-free growth and your income tax liability won’t increase.
Pensions are also free of Inheritance Tax. If you die before age 75, you can pass on your pension to your loved ones free of tax. If you die after age 75, they will still inherit your pot, but will pay tax at their own marginal rate if they take withdrawals. They can also pass the pension on to their own beneficiaries.
Some investors decide to withdraw their tax-free lump sum before they reach age 75, as otherwise the full pension pot could be taxable in the hands of their beneficiaries. It’s a good idea to seek advice if you are considering this as there are several variables to consider.
Tax Traps to Be Aware of
Pensions are an excellent way to save on tax, but there are a few potential pitfalls that could actually cost you more:
Pensions offer an excellent way of saving tax, whether this is through a workplace scheme or personal plan. If you are a higher earner, own your own business, or are thinking of taking benefits, you may want to seek advice on the best way to maximise the tax benefits.
Please don’t hesitate to contact a member of the team to find out more about retirement and tax planning.
