As we know from our recent article ‘why pensions are paramount’, a pension is simply a long term savings plan that offers tax incentives, but what exactly are those tax incentives?
If you are under age 75, not exceeded your annual allowance and pay money into your pension yourself or if it is taken by your employer from your pay packet you should get 20% tax back from the government as an additional top up into your pension. It doesn’t stop there, if you are a higher rate tax payer you can claim an extra 20% tax relief and additional rate tax payers can claim an extra 25% relief. Sounds too good to be true right? In this case it’s really not, the government will give you tax relief up to a certain amount for contributing into a pension and effectively deferring your income until retirement. So how does this work?
If you are entitled to receive 20% tax relief this does not mean you get 20% back of what you contributed, instead HRMC calculate the earnings on your contribution amount before tax was deducted and then provide the difference between your contribution and your pre-tax earnings.
To put this into context the table below illustrates the tax boost/relief available to basic, higher and additional rate tax payers assuming they are looking to contribute £100 gross into their pension:-
| Basic rate | Higher rate | Additional rate | |
| Your contribution | £80 | £60 | £55 |
| Tax relief available | £20 | £40 | £45 |
| Total amount contributed | £100 | £100 | £100 |
There is technically no limit on how much you can pay into a pension but there are limits on how much tax relief is available. You are only able to get tax relief on contributions up to your annual earnings capped at £40,000 per year. Since April 2016 if your adjusted income (i.e. including yours and your employers pension contributions) exceeds £150,000 in a year, for every £2 earned over £150,000 this allowance tapers down by £1 meaning if you earnt £160,000 your annual allowance would be £35,000. You may be able to carry forward any unused annual allowance from the previous three tax years to top up your allowance for the current tax year, this is a complicated area and guidance should be sought before making substantial pension contributions.
Pensions are often seen as complex and difficult to understand, but in fact for many people in retirement they are often one of their biggest assets. Getting a plan in place is crucial to maintain your standard of living in retirement.
Non taxpayers are also entitled to tax relief on pension contributions, albeit this is capped to an annual net contribution of £2,880, which would be grossed up with tax relief to £3,600. That’s a £720 contribution from HMRC even though no tax has been paid, now that’s what I call free money!
I would also like to add that there is no other bank account or indeed investment where your contribution / deposit will attract tax relief in this way.
In addition, any growth/profits on your pension plan are completely tax free! What’s not to like?
Why not use this pension calculator to see how much you could have in the future and if your pension savings are really on track for your desired lifestyle in retirement.
If you would like to discuss your current pension plans or what options are available to you in retirement please do not hesitate to get in touch today.
Published by: Benjamin Wooltorton
benjamin.wooltorton@michaelambrose.co.uk