As an incentive to save for a future beyond work, the government ensures that pensions are incredibly tax-efficient.
When you come to take your pension, you’ll usually be able to take up to 25% of it tax-free. But the tax efficiency begins long before your retirement date.
You receive tax relief on every pension contribution you make. The relief is automatically applied at the basic rate of tax (20%) but those who pay higher- or additional-rate tax can claim extra relief through their self-assessment tax return.
Recent figures, however, suggest that 8 out of 10 higher-rate taxpayers aren’t claiming the extra relief. Collectively, this group is missing out on an estimated £810 million.
Are you one of them?
Pension tax relief turns 100 years old
The Finance Act of 1921 introduced legislation that paved the way for our current system. That means that tax relief celebrates its 100th birthday this year.
The measure has been successful in incentivising pension saving, though it has also been helped by the introduction of auto-enrolment in 2012.
The government estimates that tax relief for the 2019/20 tax year will “cost” around £41.3 billion.
Recent figures from Aegon, meanwhile, suggest that based on pension contributions of £100 a month over a whole career, tax relief could be worth £70,000.
So, how does tax relief work?
You can receive tax relief from the government at the highest rate of tax you pay.
As a basic-rate taxpayer, a £100 contribution to your pension is topped-up by the government at the basic rate of 20%. For each £100 contribution you make, the value of your pension increases by £125.
You don’t need to do anything to receive tax relief at 20%. You’ll receive 20% tax relief on your contributions even as a higher- and additional-rate taxpayer too. The difference is that as a non-basic-rate taxpayer, you could be claiming more.
As a higher-rate taxpayer, for example, a £300 contribution could be topped up to £500 (40%). But only the first 20% is received automatically. You’ll need to use your self-assessment tax return to claim the extra 20%.
If you’re an additional-rate taxpayer, you can claim additional tax relief of 25% in the same way, up to the amount of any income you have paid 45% tax on.
Make the most of your pension Annual Allowance
Your Annual Allowance is the amount you can contribute to a pension each year while still receiving tax relief.
For the 2021/22 tax year, it stands at £40,000 (or 100% of pensionable earnings, if lower). You can contribute up to this amount and still receive tax relief. However, different allowances could apply in some circumstances.
Withdrawing pension funds using some flexible options could trigger the Money Purchase Annual Allowance (MPAA). This lowers your allowance to just £4,000, severely reducing the tax-efficient pension contributions you can make in the future.
As a high earner, you could also trigger the tapered annual allowance. While the calculations aren’t simple, the pensions taper effectively reduces your Annual Allowance by £2 for every £1 of adjusted income you receive over £240,000. The taper applies down to a minimum Annual Allowance of £4,000.
Understanding the allowance that applies to you is crucial to making tax-efficient pension contributions, so if you aren’t sure, contact us now.
Get in touch
Pensions are incredibly tax-efficient, but to make the most of your retirement you’ll need to take full advantage of these tax efficiencies.
That means ensuring you make the most of the pension Annual Allowance, thinking carefully about the options you take at retirement, but also being sure to claim all of the tax relief due to you.
If you would like to discuss claiming tax relief, or any other aspect of your pension or long-term retirement plans, contact us to find out how our Chartered Financial Planners could help.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.
