9th March 2016 at 10:37am
Pensions made the headlines over the weekend (5-6 March) as the Government announced it wasn’t going to make any major changes to pension tax relief in the Budget on 16 March.
So, despite weeks of mounting speculation it is business as usual for pension saving, but the recent debate around pension tax relief has at least reinforced the benefits of current pension tax rules. Here’s why.
The combination of tax breaks on pension saving, access to your pension pot from the age of 55, and the ability to leave a tax-efficient legacy to your loved ones makes pensions the most effective place to save for your retirement.
Tax relief on pension saving
Contributions into pensions get tax relief from the Government which means a £100 pension top-up costs you less when the tax relief is taken into account:
- £80 for a basic rate (20%) taxpayer;
- £60 for a higher rate (40%) taxpayer; or
- £55 for an additional rate (45%) taxpayer.
If you’ve joined your employer’s pension scheme you may also get a pension top-up from them – it’s essentially more free money on top of the tax benefits you get on your own pension saving.
There’s no UK tax on your pension pot’s investment growth. This is the same treatment which savers enjoy from an ISA but, because pension funds are boosted at the outset with the addition of tax relief, you get tax-free investment growth on a bigger fund.
Taking money from your pension
When it comes to drawing money from your pension, up to 25% of your total savings pot can be taken tax free. Anything else you take from your pension pot is taxed as income.
You don’t pay tax on the first £11,000 of your ‘taxable’ income (in 2016/17), with the next £32,000 taxed at 20%. The 40% tax rate applies to the slice of your income above £43,000.
A very important consideration, highlighted by research from the Centre for Policy Studies, is that fewer than 1 in 7* higher rate taxpayers will still be paying higher-rate tax in retirement.
This means most of us will pay less tax in retirement as our income tends to fall when we stop working.
If you do choose to take your entire pension fund in one go, all your pension income is taxed in a single tax year. The result could be that you will pay tax at 40% – or even 45% – on a large slice of your pension.
Pass on more of your money
Pensions also allow you to pass on more of your money tax efficiently, or even tax free, on your death. And they are typically Inheritance Tax free, unlike most other types of savings which are included in your estate.
Any remaining pension funds can be passed on to your chosen beneficiaries who can continue taking an income from it whenever they want. If you die before the age of 75, they’d get this free of income tax.
With Government top-ups on contributions, tax-free investment returns and a 25% tax free lump sum in retirement – and the ability to pass on your savings to your loved ones tax efficiently – it’s easy to see why pensions are a good way to save.
*source: Centre for policy studies
A personal pension is an investment and its value can go up or down and may be worth less than you paid in. Laws and tax rules may change in the future.
The information in this blog or any response to comments should not be regarded as financial advice and is correct as of March 2016.