A pension plan is more than saving for your old age.
It is actually an investment – and it could potentially be the most rewarding investment you ever make, thanks to the wonders of compound interest and the generosity of the taxman, who will add to every pound you contribute.
Being so rewarding has two consequences. The first is that it makes sense to maximise the contribution you make.
The second is that the government has had to set a limit on the amount you can put in.
At Continuum we are looking at why and how you should think about maximising your pension pot.
Free money from the government
One of the main reasons for maximising pension contributions is free money from the Government, in the form of tax relief.
Under current rules, this is paid into your pension pot at the same rate that you pay income tax. So, if you are a basic rate taxpayer, paying 20% tax, you get 20% tax relief.
This means that putting £1 into you pension pot will actually only cost you 80p. Things are even better for higher rate taxpayers, paying a 40%. That £1 will cost just 60p, and if you are in the highest bracket, paying at 45%, investing that £ will cost you just 55p.
But there are limits to the government’s generosity.
What is the pension allowance?
Fearful of handing over the entire contents of the treasury to pension savers, the government limits how much you can contribute each year. This is known as the pension allowance, and includes your contributions to your pension, those from your employer and your pension tax relief.
For most people, the annual allowance is £60,000 or the amount of your annual salary, whichever is lower. If you don’t work or earn less than £3,600 a year your annual limit is £3,600, which means you can pay in £2,880 tax-free and the £720 tax top-up from HMRC makes it up to £3,600.
Things are more complicated for higher earners. The annual pensions allowance reduces by £1 for every £2 your adjusted income rises above £260,000. This “tapered” allowance keeps falling until it hits £10,000 a year.
If you exceed the annual allowance, you will face a tax charge on the excess contributions. This charge essentially removes the tax relief on those excess contributions but does not result in additional penalty beyond this.
Once you begin drawing a pension your annual pension allowance reduces. This is known as the money purchase annual allowance, which caps contributions at £10,000 (to stop people doubling up on the tax benefits – contributing, withdrawing and then recycling that money back into a pension and getting more tax relief.
Lifetime allowance
There is no longer a maximum pension pot.
There used to be a cap on how much you could save – known as the lifetime allowance – most recently at £1,073,100. Any excess was taxed at 55%. The lifetime allowance was scrapped in April 2024 which means that you can save into your pensions without the concern of a tax charge should you breach the limit.
The new labour government had pledged to reintroduce the lifetime allowance before the general election, however, there currently does not appear to be any certainty as to whether this will happen.
Can you backdate contributions?
If you haven’t used your full pension allowance in the past three tax years, you may be able to carry forward those unused allowances. The annual allowance was increased to £60,000 in April 2023. Using carry forward from previous tax years, when the allowance was lower, could allow you to contribute up to £140,000 in addition to this year’s £60,000 allowance. This means you could potentially pay in up to £200,000 into your pension this year if you’ve made no contributions in the last three years.
However, the total amount you can contribute is still limited by your earnings. You can only contribute up to 100% of your annual salary in a given year to qualify for tax relief. So, while the carry forward increases your allowable contributions, you cannot contribute more than your earnings for the year.
Is there an age limit on pension savings?
You can still make payments into your pension after you have reached 75, but you won’t get any more tax relief.
But there is no lower limit. Up to £2,880 can be put into a self-invested personal pension or SIPP for under-18s each year to which HMRC adds £720 in tax relief, giving a total of £3,600. Starting a pension for your newborn could be a very sensible idea.
How much should you be paying into a pension?
The more you save, the more comfortable your retirement could be, but most of us simply can’t afford to maximise our contributions.
To understand how much you may need in your pension pot, and how much you may need to contribute to build it effectively. You should consider seeking expert advice.
At Continuum we can help you look at your pension plans and find ways to help make your contributions work harder for you.
With pensions, it’s never too early to start – so call us today.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable investment or retirement strategy, you should seek independent financial advice before embarking on any course of action.
A pension is a long-term investment; the fund value can go down as well as up and this can impact the level of pension benefits available. Pension Income could also be affected by interest rates at the time benefits are taken. Pension savings are at risk of being eroded by inflation.
The Financial Conduct Authority does not regulate taxation advice.
Levels, bases and reliefs from taxation are subject to individual circumstances and may be subject to change.
The FCA does not regulate taxation advice.
