This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Wealth Solutions in Edgbaston, Birmingham.
When it comes to saving tax-efficiently for your retirement, few tools are as useful as a pension. Yet many people – particularly higher earners – do not make the most of the benefits offered by their pension scheme(s). In this article, our Midlands-based financial planners here at Wealth Solutions show how pension benefits work and offer ideas on how to maximise them.
We hope this is helpful to you. If you’d like to speak to an independent financial adviser then you can reach us via:
T: 0121 446 5815
E: [email protected]
How tax relief works
Where should you build up your retirement savings? You could open a general investment account (GIA), of course. Yet any capital gains and income you generate may be subject to tax. With a pension, however, any investment growth is shielded from tax. If you sell a fund within your pension at a profit and buy another one, for instance, the profit will not be subject to capital gains tax (CGT). Moreover, any contributions you make receive “tax relief”.
This is significant because tax relief effectively amounts to a 20% “boost” – perhaps more – to your pension contributions. Over years and decades of investing into your pension, therefore, this can amount to £1,000s or £10,000s of extra growth towards your retirement. The amount of tax relief you get is equivalent to your highest rate of income tax. Those on the Basic Rate, as such, get a 20% “boost” whilst those on the Higher Rate get 40%.
For the former to make a £1 pension contribution, therefore, it only “costs” them 80p. For the latter, however, it only “costs” 60p. In effect, the government puts the tax you would have paid on your contribution straight into your pension.
Maximising your benefits
It is crucial to ensure you are not missing out on any available tax relief. This could affect your quality of lifestyle in retirement. First of all, if you are employed full-time (with no other income), then you should be enrolled on a workplace pension. Here, your employer will make their own contributions – say, 3% of your salary (the statutory minimum) – and you need to put in at least 5%. If you earn under £50,000 per year, then the tax relief on your contributions should be handled automatically via the PAYE system. You can check your scheme’s documentation or online “portal” to check that this is being administered correctly (e.g. getting the 20% “boost”).
Things get a bit more complicated, however, if your salary is over £50,000 per year. Here, you need to claim the extra 20% tax relief on your pension contributions via your Self Assessment tax return. Many people do not know this, however, or they forget/fail to fill out the paperwork before the deadline. A financial planner can be very valuable in this respect – guiding you to get the most from your benefits, in good time. You can also contact HMRC directly about tax relief.
Those who are self-employed – or generate self-employed income on the side (perhaps placing them in the Higher Rate bracket) – also need to take care to review their tax relief, carefully. This also involves filling out a Self Assessment to get the most pension entitlement.
Pitfalls to bear in mind
Pensions are fantastic for retirement saving. However, they do have certain caveats that you need to navigate carefully. Without careful planning, falling into one – or more – of the following common pitfalls can erode, or even wipe out, the extra gains from your tax relief.
First of all, pension money cannot be accessed before age 55 (rising to 57 in the future). As such, make sure that anything you “lock away” will not be needed before then. Secondly, be careful to keep within your annual allowance for pension contributions. This limits you to put up to £40,000 – or 100% of your earnings (whichever is lower) – into your pension(s) each tax year. Going over this risks a penalty.
Thirdly, be careful with the Money Purchase Annual Allowance (MPAA) rules. When triggered, these reduce your annual allowance to £4,000 – a 90% drop! This can happen inadvertently, for instance, when someone wants to continue working but also start drawing pension benefits from the age of 55. As such, you need to be aware of the MPAA rules and not to trigger them unless you are sure you want to. A financial planner can help advise you here.
Finally, be mindful of the Lifetime Allowance. This limits the total amount that you can save into your pension(s), and is capped at £1,073,100 in 2022-23. Anything you withdraw as a lump sum over this threshold is taxed at 55% (or 25%, if taken as income). Many people run the risk of crossing over this limit inadvertently – e.g. senior professionals in the NHS. With good forward planning, you can help avoid this danger by considering other tax-efficient vehicles alongside your pension – such as ISAs, which do not have a total “cap” on the investment value inside.
We hope this content has been informative and inspired you to make the most of your pension benefits. Please get in touch if you’d like to discuss these matters with us via a free, no-commitment consultation with a member of our team:
Reach us via:
T: 0121 446 5815
E: [email protected]