An article by FTAdviser reveals that in January 2023, HM Revenue and Customs estimated that Income Tax relief on pension contributions stood at almost £27 billion in 2022/23. The article is a timely reminder that while we might believe that the government only wants to take our money, it does, in some situations, give us money as well.
One of those occasions is the tax benefits HM Revenue & Customs provide with pension contributions, which can be used to significantly boost your retirement fund. Furthermore, in his 2023 Budget, the chancellor announced changes to important allowances which could provide even greater tax relief on your pension contributions.
That said, understanding those rules and maximising your pension’s tax efficiency can be tricky to understand. With this in mind, read on to discover five important pension tax relief rules, and why ensuring that your pension is tax-efficient could provide a better standard of living in retirement.
1. Contributions must come from “relevant earnings”
Not all types of earnings receive tax relief when they are used to make pension contributions. Only “relevant UK earnings” enjoy relief, which includes:
- Income from employment, such as your salary, bonuses and or commission
- Redundancy that’s above the £30,000 tax-exempt threshold
- Benefits in kind that are taxable
- Income from a trade, profession or vocation, as well as earnings from a patent
- Rental income from UK holiday lets.
As this is not an exhaustive list, a financial planner will be able to confirm whether the way you take an income is seen as relevant earnings, and what your options might be if it’s not.
2. Every £100 you contribute could cost you £80 or less
When you contribute to your pension, the government typically refunds the Income Tax you would have paid on the money you use. This means that you pay just £80 for every £100 you place into your pension if you’re a basic-rate taxpayer, or £60 if you’re a higher-rate taxpayer. Additional-rate taxpayers may only pay £55.
Maximising your pension contributions may provide your retirement fund with a significant boost in a relatively short space of time, which could mean that you have a better standard of living when you finish working.
As strict rules apply, speaking to a financial planner can ensure that you don’t fall foul of HM Revenue & Customs regulations, and potentially end up facing an unexpected tax liability.
3. Tax relief on contributions is limited
While you can have any amount in your pension pot, the amount of money that receives tax relief is usually limited by the Annual Allowance and Lifetime Allowance.
The Annual Allowance is the amount of contributions that you can make every year that receives tax relief. In 2022/23, this is typically £40,000 or the amount you earn, whichever is the lower.
However in his 2023 Budget, the chancellor announced the Annual Allowance would increase to £60,00 or the amount you earn. The increase comes into effect in April 2023.
If you earn more than £240,000 a year in 2022/23, or more than £260,000 a year in 2023/24, your allowance may be significantly reduced using “tapering” rules. As the rules are complex, a financial planner will be able to confirm whether the tapering rules affect you.
Furthermore, in 2022/23, the amount of money you can have in your DB pension pot that enjoys tax relief is restricted by the Lifetime Allowance, which stands at £1,073,100. This means that any amount that you withdraw from your pension pot that’s above the £1,073,100 threshold could be liable to an LTA tax charge of up to 55%.
There is good news though, as the chancellor also announced that the LTA would be abolished as from April 2023. This means that there will no longer be an LTA tax charge on withdrawals from your pension pot.
4. You may be able to boost your annual contribution using “carry forward”
If your pension contributions exceed your Annual Allowance, you could receive a tax charge. That said, you may be able to contribute more than your allowance using “carry forward”.
Carry forward uses unspent Annual Allowance from the previous three years, which may mean that you can contribute up to £160,000 in 2022/23 and still receive tax relief. This could increase to £180,000 in 2023/24.
As a result, you may be able to give your pension pot a significant boost if you have a lump sum, such as an inheritance or a significant redundancy payment. Strict rules apply to carry forward, so always speak to a financial planner to ensure it’s right for you and that you don’t accidentally expose yourself to an unexpected tax charge.
5. Tax relief can be claimed in two different ways
How you claim your tax relief depends on whether your pension is a “net pay” scheme or “relief at source”.
If your pension is net pay, your employer will deduct contributions from your salary before Income Tax is paid. This usually applies to defined contribution (DC) pensions, often known as “money purchase pension schemes”.
These could include personal pensions, self-invested personal pensions (SIPPs) and certain workplace pension schemes.
If you have a relief at source scheme, your pension provider claims back the 20% basic-rate on the money contributed into it and adds it to your pot. As a basic-rate taxpayer, you will typically not need to do anything else.
This is not the case if you’re a 40% higher-rate or 45% additional-rate taxpayer, as HM Revenue & Customs only reimburses pension providers with the basic-rate of tax. This means that if you usually need to claim the remaining 20% or 25% back, you have to use self-assessment.
According to the Telegraph, 80% of higher-rate taxpayers do not claim all of their tax relief. If you’re one of them, a financial planner could help you claim the full amount, which might provide a significant boost to your pension pot, allowing you to enjoy a better standard of living in retirement.
Get in touch
As you can see, working with a financial planner to maximise the tax relief provided with pensions could help you build the value of your retirement fund in a relatively short period. Furthermore, they can ensure any income you take from it is as tax-efficient as possible.
If you would like to discuss your pension and how to maximise your tax efficiency, please contact us on hello@ardentuk.com or call 01904 655 330. As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, you can be sure that we’re a bona fide company providing excellent advice and high-quality service.
Please note
This blog is for general information only and does not constitute advice. 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.
The information is aimed at retail clients only. Life insurance plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse.
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.
