Your savings and investments are built up from spare cash left over from what you earn. Your earnings, however, have been taxed. Payments into your pension, in contrast, are made from your earnings before they are taxed or if they have been taxed, the tax is given back to you. This means that for every payment into your pension the Government pays you back the tax, making a contribution to your pension. In simple terms, if you are:
- A basic rate (20%) tax payer for every £10 you contribute to your pension the Government will contribute £2.50 and your pension pot will grow by £12.50
- A higher rate (40%) tax payer for every £10 you contribute to your pension the Government will contribute £6.66 and your pension pot will grow by £16.66
- If your are an Additional rate (45%) tax payer for every £10 you contribute to your pension the Government will contribute £8.19 and your pension pot will grow by £18.19
If you are:
- An employee and pay into a pension provided by your employer, tax is only calculated on your earnings AFTER your pension contribution has been deducted.
- Not an employee but you pay into your own pension, your Pension Provider will assume that your contribution has been taxed at the basic rate of 20% and will claim the 20% from the Government. If you pay tax at 40% or 45% then the additional 20% and 25% should be claimed back in your yearly Self-Assessment tax return.
Whether employed or otherwise the impact is the same – You don’t pay tax on your Pension payments, and the saving is at your highest rate of tax, so the more tax you pay the greater the tax saving.
Restrictions of Tax benefits for Pensions
This tax benefits is restricted in terms of the amount you can pay into your pension each year (Pension Annual Allowance) and what benefit you take out of your pension in your Lifetime (Lifetime Allowance). Both of these restrictions will not be relevant to most pension holders but you should determine they do not impact you.
If you are evaluating your pension, we strongly advise that you seek professional advice from a fully qualified and regulated Independent Financial Advisor. Pension decisions are usually a major financial decision that requires the appropriate level of advice to make the right choice. In contrast, mistakes can be costly. To arrange for a no obligations, initial free telephone consultation click here.