Making the most of your pensions, from a tax perspective

In light of Pension Awareness Week which is running from 9^th September 2024 to 13^th September 2024, Ashley Stoller, Private Client Tax Manager, reviews the various tax benefits available to individuals on contributions to pensions schemes. He also considers the tax implications when you are eventually able to withdraw from your pensions.

The aim of this campaign is to boost people’s interest in their pensions and highlight the importance of preparing and saving for retirement. Pension tax, like most areas of taxation is overly complicated, but funding pensions can be extremely tax efficient. Alongside the future planning benefits (i.e. being financial stable when you are finally able to put your feet up after decades working hard) the tax benefits, both on initial contribution and during the growth phase of your pension, should not be ignored.

Initial contributions

Most individuals in the UK are basic rate taxpayers, i.e. they pay 20% tax on their income. For these individuals, contributing to your pension is usually made in one of three ways (or a combination of the three).

1. Through salary sacrifice, where the income is deducted from their gross pay before they pay tax and national insurance. Practically this means that if a basic rate taxpayer were to put £100 into their pension via salary sacrifice, they would save approximately £28 in tax and national insurance meaning that it would have cost £72 to put £100 into their pension. The same would apply to higher rate payers, expect the tax and national insurance saving would be 42% meaning a £100 contribution would only cost £58.
2. Through employer contributions, where your employer contributes to the pension for you. You are not taxable on the contributions made by your employer to the pension scheme and the company receives a corporation tax deduction. For owner managed businesses this can be effective part of their remuneration planning.
3. Through personal contributions made directly to the pensions scheme. Using this method, there are no national insurance savings, but there are still considerable tax savings. Using the same example above, if a basic rate taxpayer were to put £80 into a private pension HMRC will automatically top up the pension with the basic rate tax, being £20. Therefore, the pension scheme would have received £100. Similarly, if you are a higher rate taxpayer and put £80 into your pension, HMRC will top it up by £20 and you can claim an additional £20 tax back from HMRC when you complete your tax return. Making the net cost of a £100 contribution only £60.

This can be a very efficient tax planning tool. Where individuals are about to go into a higher tax band, they can increase their pension contributions to mitigate their exposure to higher rates of tax.

One of the most beneficial times to do this is when start to earn over £100,000 per year. Once you start to earn over £100,000 you lose £1 of your tax-free personal allowance for every £2 of income earned over the £100,000 threshold. This means that the effective tax rate of earnings between £100,000 and £125,140 is 60%!

Using an example, if someone earns £110,000, the £10,000 of income above £100,000 would be taxed at 60%. Meaning £6,000 of tax would be paid on that £10,000 of income. However, if you were to transfer £8,000 into your pension scheme, all your tax bands and tax-free personal allowances limits are increased. HMRC would top the pension contribution up by £2,000 and you could claim back £4,000 through your tax return. Therefore, £10,000 would be added to your pension for a net cost of only £4,000.

Tax free growth

One of the other biggest tax advantages of pension schemes is that the growth and income within the scheme is free from tax. If you held the investments personally you would be subject to income tax and capital gains on any growth or income within the scheme. However, whilst the funds are invested in the scheme the income and gains are tax free. This has two main benefits:

1. No tax cost.
2. Money that would be spent on tax costs remains within the scheme to generate further growth.

Most pensions are also outside the scope of inheritance tax.

Saving for your children

Parents, grandparents, godparents or any other individual can start a pension scheme for children and contribute up to £2,880 into their pension scheme per year. HMRC will top this up with the usual tax relief meaning that £3,600 per year will be added to their pension scheme.

If parents do this for 18 years their children would have nearly £65,000 in their pension as soon as they become an adult, before factoring in any investment growth.

Eventual withdrawals

When the time comes and a decision is made to withdraw monies from your pension it is normally taxed at your marginal rates.

Normally and in most cases it is possible to access a 25% tax free lump sum from your pension.

How can we help you with your pension and tax planning?

A lot of people do not realise that there are various limits on how much you can put into a pension whilst still receiving tax relief. Anyone can put £3,600 (gross) per year into their pension. But after this, there are various limits imposed based on your income levels and type of income received.

There are countless tax planning opportunities with pension contributions and pension withdrawals. The key is having efficient and up to date tax advice. It is also imperative that proper financial advice is sought before making decisions regarding pension contributions and withdrawals.

As one of my favourite sayings goes – “don’t let the tax tail wag the investment dog”. i.e. don’t make major life and investment decisions solely based on the tax considerations, but make sure you understand the tax implications!

If you would like to speak to a member of the team to find out how we can assist you, please contact us and a member of the team will be pleased to help.

Follow the social conversation online using the hashtag #PAW24 #PensionAwarenessWeek

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