Understanding pensions is no easy task. With a myriad of rules and regulations, tax benefits and tax traps, it’s easy to fall foul of HM Revenue & Customs or inadvertently reduce the value of your pension pot at retirement.
That’s why speaking to a financial planner about your pension is typically the best strategy. Planners have passed a series of exams to become licensed to advise, and have to demonstrate to the Financial Conduct Authority (FCA) that their knowledge is always up to date.
All that said, if you have a better overall understanding of pensions, it could provide you with peace of mind and help you ensure that your pension is on track to meet your goals. So, with this in mind, discover 10 pension tips you need to know.
1. The government helps boost your pension
When you contribute money to your pension, the government typically gives you an uplift using tax relief. If you’re basic-rate taxpayer, every £100 you contribute only costs you £80, and if you’re a higher-rate taxpayer, it costs just £60. Additional-rate taxpayers pay £55 for every £100 contribution.
2. The amount of tax relief on contributions is limited
The amount of money contributed to your pension that receives tax relief is limited to your Annual Allowance. In 2021/22, this is the amount you earn or £40,000, whichever is lower.
Additional-rate taxpayers need to be aware of the Annual Allowance tapering rule. If triggered, it drops your Annual Allowance to £4,000 (2021/22).
3. “Carry forward” may mean you can make larger contributions
If you have a significant lump sum such as an inheritance, “carry forward” could allow you to contribute more than your Annual Allowance and still receive tax relief.
This is because it allows you to use unspent amounts from the previous three years’ allowances, which may mean you can contribute up to £160,000 in the 2021/22 tax year.
4. Not enough risk could put your retirement at risk
As pensions are investments, they’re typically made up of stocks and shares, government bonds, cash and even property. As potential growth typically comes from higher-risk stocks and shares, exposing your pension to low levels of risk could reduce its growth potential over the long term, and significantly reduce its value when you come to retirement.
This might mean your pension cannot provide the lifestyle you want when you finish work.
5. Many higher-rate taxpayers don’t claim all their tax relief
Typically, the government boosts your pension by the basic rate of tax (20% in 2021/22) without you needing to do anything. If you are a higher- or additional-rate taxpayer though, you will need to claim the additional 20% or 25% using self-assessment.
According to the Telegraph, 80% of higher-rate taxpayers do not claim their additional tax relief. If you’re one of them, the article explains you could be £2,000 worse off if you’re contributing £8,000 a year into a pension.
6. Your pension could reduce your Income Tax liability
If you receive a salary increase that pushes you into a higher tax band, you could use your pension to reduce your Income Tax liability. By agreeing a “salary sacrifice” with your employer, they increase your pension contributions and reduce your salary by the same amount.
This could drop your income back down into the lower tax bracket, reducing your Income Tax liability from 40% to 20%, or 45% to 40%. Remember, salary sacrifice could affect your ability to get a mortgage and have an impact on other benefits such as your death in service package.
7. Consider increasing contributions to your workplace scheme
If your employer will match your pension contributions, be sure to contribute as much money as possible – subject to the Annual Allowance. Some employers match contributions even if you contribute more than the 5% that you’re required to, which could boost your pension pot substantially.
This is because your pension benefits from “free money” from your employer, and typically, tax relief on the total amount contributed.
8. Pensions benefit from compounded growth
Pensions typically benefit from compounded growth, which is growth on the growth your pension has already made. Starting a pension as early as possible means you benefit from more years’ compounded growth, which could significantly boost your retirement fund.
9. Employers may pay into your private pension
Some employers will now pay workplace pension contributions into a personal pension of their employee’s choice. While doing this might give you more control over your pension fund, care should always be taken, and you should speak to a financial planner to ensure it’s right for you.
10. Your pension could help tackle climate change
According to Pension Age, switching your pension into sustainable funds could be a very effective way to combat climate change.
Researchers found that moving a £100,000 pension to Environmental, Sustainable and Ethical (ESG) funds could be 40 times more effective in tackling climate change than switching to a renewable energy provider.
Get in touch
Always speak to a financial planner if you are considering any of the points included in this blog.
Adjusting your risk, taking salary sacrifice, or switching to an ESG fund all have implications for your pension, and could cost you dear if not done correctly. A financial planner could also help you claim all your pension tax relief if you are not already doing this.
If you would like to discuss your pension or retirement strategy in more detail, please contact us at hello@ardentuk.com or call 01904 655 330. As award-winning specialists in financial planning, we’ll help you look forward to a brighter future and provide peace of mind that you’re financially secure.
Please note
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
