According to the government’s last review into pension tax relief, its primary purpose is to strengthen the incentive to save. But what exactly is pension tax relief, how does it work, and can you make it work any harder?
The government is keen on you saving for your old age. We are all living longer, and the Exchequer cannot afford to support the growing millions of pensioners though a state pension. So, the government provide tax relief as a way to encourage us to save for our future.
So, when you pay into your pension, some of the money that you pay in tax on your earnings goes into your pension pot rather than into the government’s coffers.
Tax relief is paid on your pension contributions at the highest rate of income tax you pay. So basic rate taxpayers get 20% pension tax relief, an extra 20% added to their pension pots automatically. Higher-rate taxpayers can claim 40% pension tax relief, and additional-rate taxpayers can claim 45% pension tax relief (as per tax year 2019/2020).
To put it another way, every pound a basic rate taxpayer puts in their pension pot costs them 80p, while the same pound costs a higher rate tax payer just 60p.
This means that even before the wonders of compound interest and skilled investment management get to work, your pension has already earned you money on the day you pay into it.
The limits on tax relief
In fact, the benefits of pension tax relief are so good that the government has imposed certain limits. The maximum you can contribute to a pension and earn tax relief is £40,000 or the maximum you earn in a year – although, you can carry forward unused allowances from the previous three years.
It is also subject to a lifetime allowance of £1.055m for 2019/20 and is expected to increase to £1.073 million from 6th April 2020. This may sound an impossibly high figure for most people, but it can actually be fairly easy to reach for someone on a good salary, 40 years of pension contributions and skilled investment from fund managers.
If you fall into the pensions taper and the changes which will come into effect following the budget, it can be vital to get expert advice from the Continuum team.
At the other end of the scale, non-taxpayers, including spouses who aren’t in employment and children, are eligible for tax relief of 20%, even though they don’t pay tax. As a non-taxpayer, the maximum you can contribute is £3,600. This includes the government top-up, so your personal contribution will cost you just £2,880.
How to claim pension tax relief
The way tax relief is claimed depends on the type of pension scheme you have. A ‘net pay’ arrangement is used by some workplace pensions and does not require you to do anything to claim your full tax relief. Your pension contributions are deducted from your salary before income tax is paid on them, and your pension scheme automatically claims back tax relief at your highest rate of income tax.
‘Relief at source’ is a little more complicated and applies to all personal pensions and some workplace pensions. So, if you have a private pension with an insurance company, or a self-invested personal pension or SIPP you may need to make sure you are getting the pension tax relief you are entitled to.
If you’re paying into an employer’s pension, your employer will take 80% of your pension contribution from your salary and sends a request to HMRC, which pays an additional 20% tax relief into your pension. This should be handled by your pension administrator for you.
However, under this system, higher and additional-rate taxpayers must complete a self-assessment tax return to receive the extra relief they are entitled to, which they will receive a reduction in the tax they pay.
Getting some help
Tax and pensions both start out simple and rapidly become complicated, which means that it is always worth getting expert help.
At Continuum we are expert in both tax and pensions, and that means we know the ways to deal with your questions, and to ensure that you use your entitlements to the full. So a call to us could help you deal with the maze of questions if you are affected by the taper allowance, or let you use measure like contributing to the pension of your spouse to make use of their allowances as well as your own.
If you are looking to pay less tax and build a bigger and better pension pot, call us now.
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 strategy, you should seek independent financial advice before embarking on any course of action.
Levels and basis of reliefs from taxation are subject to change and depend upon your personal circumstances.
The value of your pension and investments can fall as well as rise and you may get back less than you invested.
The Financial Conduct Authority does not regulate taxation advice.
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