It pays to know how pensions are treated by the HMRC. In this article we delve into the 10 pension tax benefits and pitfalls you need to know about – this tax year and beyond.
Published on 17 Feb 2022Last updated on 06 Apr 20228 minute read
Written by Adrian LoweryContributors: Louise Higham
The tax treatment of pensions makes them both an attractive long-term savings option, and a complicated one. Let’s take a closer look.
Tax relief boosts the value of your pension pot immediately. It’s granted automatically at 20% of the amount going into your pension (on a contribution up to 100% of your earnings within the annual allowance of up to £40,000), while higher-rate taxpayers can claim back an extra 20% and additional-rate taxpayers 25%. Make the most of your tax reliefs and understand the rules.
If your company offers salary sacrifice, the tax benefits of pensions could be even greater. Your company may allow you to reduce your salary or bonus payments in lieu of increased pension contributions. As a result, both you and your employer will pay lower National Insurance contributions (NIC) – set to rise in April – and this makes pension saving even more tax efficient. If you are close to the £50,271 earnings threshold where the higher 40% tax rate kicks in, you could dip under it by using salary sacrifice pension contributions.
Expert tip: There are disadvantages to agreeing to a lower salary, such as affordability calculations when it comes to applying for a mortgage. Employee benefits such as life cover, and holiday, sickness and maternity pay could also be affected. Employers offering such schemes should provide you with personalised calculations of how it will affect your take-home pay and benefits, and how it will boost their contribution to your pension if at all.
For most people the total sum of personal contributions, employer contributions and Government tax relief can’t exceed the annual personal allowance of £40,000 (2022/23). And you can’t contribute more than 100% of your earnings to a pension during the tax year, so if your salary is lower than £40,000 then you are limited to contributing your annual earnings into pensions. More rigid and complicated rules apply for the very highest earners under a tapering allowance that can reduce the annual allowance to as little as £4,000.
Expert tip: The lifetime allowance is the limit on how much you can build up in pension benefits over your lifetime. It is currently £1,073,100.
Find out more about more about your pension allowances.
In 2010/11 the pension annual allowance was £255,000. As it is now £40,000 it is affecting a lot more savers than it used to. Pension carry forward rules allow you to use unused allowances from up to three prior tax years in the current tax year – provided you have maximised your current annual allowance, and you were a member of a pension scheme in the tax year you are carrying forward. You could potentially carry forward up to £120,000.
The major drawback of pensions for some savers is that the money is locked away once committed. But up to 25% of your pension pot can be accessed tax-free – with the remaining 75% available as taxable income – from private pension access age (set to rise from 55 to 57 in 2028). This is certainly not to say that this is the right thing to do. But for savers aged 50 and over, the limits on access become less meaningful compared to the money benefits of saving into a pension. Explore your retirement options in more detail with our helpful guide.
Those planning to access their pension flexibly, either this tax year or next, need to think carefully about both the tax impact and the effect it will have on their ability to save further amounts into pensions in the future. After you turn 55 you can take flexible payments from your pension in a way that works for you (and preferably after you have received advice on how your flexible withdrawals will affect your retirement income). This could be a one-off withdrawal, regular payments or a series of lump-sum payments as and when you want them.
Anyone who makes a flexible withdrawal from their retirement pot beyond the 25% tax-free lump sum triggers the money purchase annual allowance. This permanently slashes their annual allowance from £40,000 to just £4,000 and revokes the privilege to carry forward unused allowances from previous tax years. This measure was introduced to stop people recycling money through pensions to benefit from extra tax-free cash.
When you take a flexible payment from your pension, HMRC assumes it is just the first of 12 monthly withdrawals. As a result, this first flexible withdrawal from your pension pot is likely to be taxed at an emergency rate and will probably mean you are significantly overtaxed.
You can get this money back through your self-assessment tax return, or by applying by form to HMRC.
If you or your partner have registered for and claim child benefit, and one of you earns more than £50,000 a year, you’ll be liable for the high-income child benefit tax charge. This can be a major irritation for some couples as it needs to be paid through self-assessment. The charge increases gradually depending on how much you earn.
Your pension contributions lowers your total adjusted net income, which is how the HMRC works out whether you are liable for the child benefit tax charge. If your pension contributions scale back your adjusted net income to sit below £50,000 you can avoid the charge. If your adjusted net income total is between £50,000 and £60,000 the child benefit tax charge will be reduced.
Expert tip: If you are affected, the sensible option is to register for child benefit but opt to not receive it so you don’t have to pay the tax charge but still accumulate NI credits.
Pensions are an important part of tax and inheritance planning. It’s essential that you arrange for your pension to go where you want it to when you die – particularly as this can change according to your family circumstances.
Expert tip: Nominating a pension beneficiary is usually something that can be done in a matter of seconds online and can result in a massive tax saving for your loved ones.
Even savers who don’t pay tax - such as a partner who isn’t employed or children - can still pay into a pension and receive 20% tax relief. In this case, the ceiling on annual pension saving is £3,600, made up of your contribution of £2,880 and £720 from the Government.
At Bestinvest we do more than talk about saving you money. We offer a low-cost SIPP* (Self-invested Personal Pension) that gives you control over where your pension savings are invested, a great choice of investments, including cost-effective Ready-made Portfolios, help from pension experts and flexibility over how to access your pension savings when you reach 55. We also offer up to £500 towards exit fees if you’re keen to consolidate and transfer** your pensions to us. What are you waiting for? You can open a SIPP today.
The value of an investment may go down as well as up, and you may get back less than you originally invested.
This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers.
Examples of how tax or tax relief may apply are based on our understanding of current tax legislation. Whether any tax will be payable, at what level it is charged and whether you qualify for tax relief will depend upon individual circumstances and may be subject to change in the future.
*SIPPs are not suitable for everyone. If you don’t want to invest across different asset classes or don’t think you will make use of the investment choices that SIPPs give you, then a SIPP might not be right for you. Please note, other taxes may apply when taking your pension income.
** Before you consider transferring a pension, it is important to ask yourself: Will I lose any valuable benefits or features from my existing pension plan? Will I incur any penalties on my existing pension if I transfer? Is it an occupational final salary pension scheme? (in which case it is very unlikely to be advisable to transfer). Have I considered the charges on my current plan? (a new arrangement may be more expensive – especially if you have a stakeholder pension).