Pension schemes are one the most efficient forms of investment as contributions into the scheme benefit from tax relief – and that offers a huge advantage over any other form of saving plan. The ‘good news’ doesn’t stop there as, not only do you benefit when you make contributions, the money is not subject to tax while it’s invested in your pension pot and, when the time comes to receive your pension, you can usually take a portion of your pension pot huge advantage over any other form in the form of a tax-free lump sum.
Tax relief on contributions
You receive tax relief at the highest marginal rate of income tax you pay on any contributions you make to your pension scheme, providing that your total gross contribution doesn’t exceed your annual earnings or annual allowance. How you receive tax relief, and how much you receive, depends on your income, the pension scheme you are contributing to and how your pension contributions are made.
If you are a basic-rate taxpayer you automatically get 20% tax relief from the government and this is paid into your pension pot by your pension scheme provider. If you are a higher-rate tax payer you can claim an additional 20% tax relief from HMRC through your self-assessment tax return and if you pay tax at the top rate you can claim a further 25% tax relief from HMRC. (Note: the rate of tax relief in Scotland is different from England, Wales and Northern Ireland.)
Tax relief is calculated on a gross, ‘pre-tax’ basis, ie: the amount you earned, not the amount you contributed. For example, you want to make a contribution of £100 a month from your wages into your pension scheme. This figure is considered to be the net, after-tax amount so, if you are a basic-rate taxpayer you’ll receive 20% tax relief (£25) which the scheme provider claims from HMRC and adds to you pension pot, making your gross contribution £125. So, although you’ve paid £100 to your pension scheme, your pension pot has actually received £125.
If you have your own private pension scheme your contributions are usually treated as being paid net of basic rate income tax relief and, as with workplace pension schemes, your pension provider will claim back basic rate tax at 20% and add this to you pension pot increasing its size.
Annual allowance and lifetime allowance
Although you are free to pay a maximum of 100% of your wages or salary into your pension scheme, or schemes, an ‘annual allowance’ limits the amount of tax relief you can claim each year. In addition, a ‘lifetime allowance’ sets a limit on the total value of your pension pots before which you start to pay additional tax.
- Annual allowance
In his Spring Statement of 15 March 2023, chancellor Jeremy Hunt announced that the ‘standard’ level of annual allowance would be increased by 50%, rising from £40,000 per year to £60,000 per year, and the minimum ‘reduced annual allowance’ increased from £4,000 to £10,000.
This reduced annual allowance affects only those with a very high ‘threshold income’ (£200,000 from all sources). When applied, an individual’s annual allowance is reduced using a simple formula called ‘tapering’: for every £2 of income above an individual’s ‘adjusted income’ (now £260,000), the annual allowance reduces by £1 until it reaches a minimum of £10,000.
Your annual allowance is based on any private pensions you may have (but not including your State Pension), the exact figures being calculated differently depending on whether it’s a defined benefit or defined contribution scheme. For ‘DB’ schemes, it’s the total pension that has accrued during the year, whereas for ‘DC’ schemes, it’s the total amount you, your employer or anyone else has contributed in that tax year. If you have both defined contribution and defined benefit schemes then it’s a combination of the two.
You won’t receive tax relief on any contributions that exceed your annual allowance and, if you do exceed it, you’ll also have to pay an annual allowance charge.
- Lifetime allowance
In what was considered an ‘unexpected’ move, in his Spring Statement of 15 March 2023, chancellor Jeremy Hunt announced that the lifetime allowance charge would be abolished from 6 April 2024 through a future Finance Bill.
Tax on pension income
Any income you receive from a pension scheme, including your State Pension, is treated as earned income which means you may be liable to pay tax on it; your pension provider(s) using your tax code to deduct tax before paying the balance to you.
You should be able to take a proportion of your pension pot as a tax-free lump sum. This may be the first 25% in the form of a pension commencement lump sum (usually referred to as a ‘PCLS’) – see also ‘Receiving an income’ or, if you go for an uncrystallised fund pension lump sum (‘UFPLS’) income drawdown arrangement, take smaller cash sums as and when you need them, the first 25% of each being tax free.
You need to think about any potential tax implications before you receive your pension as your income strategy during your retirement will dictate what you do with your pension pot and how you receive your pension.
You don’t pay National Insurance contributions on your pension income.
How can One Financial Solutions help you?
One Financial Solutions is here to help you. We’ll work with you, assess your current circumstances, review your retirement goals and help you put in place a pension strategy to meet them, ensuring that having a ‘financially secure and comfortable retirement’ isn’t something that’s left to chance.
We’ll assess the value of your State Pension and make sure you receive everything you’re entitled to. We’ll review any workplace and private pensions you may have and recommend any changes we feel are beneficial. If you need a pension scheme we’ll find one for you and, as a truly independent firm of financial advisers, we’ll select one from the entire market and make sure it’s the best one for you.
So, if you’re looking for specific help about any aspect of your pension or just want advice on the subject, please call us on 020 3714 9565 or ask us to call you by sending an email to email@example.com.