23rd January 2017 at 3:30pm
Tax can help you save for your retirement, particularly if you are a higher- or additional-rate taxpayer.
It can make saving a lot more affordable than you might think – and it’s all down to tax relief on what you pay into your pension. Here’s how to make the most of it.
How tax relief adds up
It can be relatively simple to plan your contributions to get the greatest benefit.
As a rule of thumb, if your pension contribution falls into higher rate tax above £43,000 you’ll benefit from 40 per cent tax relief on it.
Below that, you get basic rate tax relief at 20 per cent.
What this means is that if you earn £50,000 and want to boost your pension by £7,000, with 40 per cent tax relief of £2,800, the cost to you would be just £4,200.
“Six in seven people* who pay higher rate tax when they’re working don’t pay as much when they stop.”
As you can see, planning and saving this way can make a big difference.
Plus, as you’re a UK taxpayer, the general rule is that you get tax relief on pension contributions up to 100 per cent of your earnings or a £40,000 annual allowance, whichever is lower.
Good news when you’re taking your pension too
You can make tax work just as effectively when you start to take your pension.
The good news is that six in seven people* who pay higher rate tax when they’re working don’t pay as much when they stop.
And because of the way income tax works in bands you could well pay a lot less than you think.
40% tax can actually be much, much less…
If your income is £50,000 when you retire, you only pay 40% tax on the £7,000 slice above the £43,000 higher tax threshold.
But factor in your annual £11,000 tax-free personal allowance and 20% income tax on the first £43,000 and your overall tax rate is just 18.4%.
It’s less than half the 40% headline rate and you have £40,800 to spend.
…and factoring in your tax-free allowance
Then there’s the quarter of your pension fund you can take tax free, either as a lump sum or as part of your regular income.
If you take £50,000 from your pension and take this into account, only 75 per cent is taxed. Your personal allowance and tax paid mean you take home £44,700.
Your overall tax rate is effectively just 10.6 per cent, leaving you more of your retirement income to enjoy.
The bottom line: what does all this add up to?
Tying this all together, with some planning you can get tax relief at 40 per cent when you are saving into a pension, and pay a much lower rate of tax when you take your money out.
In the examples we’ve quoted above, tax breaks alone – ignoring all investment growth and charges – mean that for every £100 you pay into your pension you could get back £148. And this doesn’t takes into account any employer contributions if you are in a workplace scheme.
If you need some guidance, simply speak to your employer or contact your financial adviser.
The information in this blog or any response to comments should not be regarded as financial advice and is based on our understanding in June 2016; and updated January 2017.
* Source: Centre for policy studies