Benefits of Personal Pensions

Tax allowances and thresholds

While tax thresholds and allowances are being reduced or frozen, there is some good news for those choosing to squirrel money away for retirement. One of the main benefits of personal pensions is the government tax relief on personal contributions. The government has also recently removed the pension lifetime allowance of £1,073,100. Previously, if your pension pot exceeded this limit, there was a tax charge.

Pension tax relief

HMRC provides pension tax relief of 20% on personal pension contributions for basic rate taxpayers, up to 40% tax relief for higher rate taxpayers and 45% for additional rate taxpayers. The tax relief for higher rate taxpayers usually needs to be claimed through an annual self assessment tax return.

The government adds 25% of your net personal pension contributions to your pension pot. This is essentially a tax rebate because the government has already taken income tax from your pay. For example, if you earn £100, you’ll pay £20 tax as a basic rate taxpayer. You contribute your net pay of £80 to your pension. The government then adds £20 (25% of £80) or 20% of your gross pay of £100 to your pension pot, effectively reimbursing you for the tax paid.

Workplace pension

If you are enrolled in a workplace pension scheme, your employer must contribute 3% of your salary to your pension. As the minimum contribution to a workplace pension is 8%, you will need to contribute 5%, or 4% of your net pay after the tax relief. There is no tax relief on employer contributions.

Annual Pension Allowance

Individuals in the UK have an annual pension allowance of £60,000 from April 2023 (previously £40,000). This is the maximum you can pay into your pension and receive tax relief. Personal contributions are limited to your annual income if this is lower than £60,000. The exception to this is high earners with income over £260,000, who have a reduced pension allowance.

If, for instance, you have annual earnings of £35,000 this is the maximum you can contribute to a pension and receive tax relief. The contributions will be made up of £28,000 personal contributions and £7,000 of tax relief.

How the pension allowance limit is measured depends on the type of pension. Usually, it includes personal pension contributions, government tax relief, and employer pension contributions.

Additionally, if you have not used your full pension allowance for the past 3 years, you may be able to carry this forward and use it in the current year.

If you aren’t currently working or not paying tax, you can save £3,600 annually into a personal pension. This comprises £2,880 personal contributions plus £720 of tax relief.

When you retire

When you retire, you can draw out 25% of your pension tax-free up to a maximum of £268,275. The remaining 75% is subject to income tax depending on your financial position.

Currently, pensions do not form part of your estate for inheritance tax. However, from April 2027 the law is changing and private pensions will form part of an individual’s estate for inheritance tax.

Some pension plans may incur an income tax charge for your beneficiaries and a possible inheritance tax charge. Some pensions are taxable if you are over 75 years of age when you pass away. As this is quite a complex area it is taking financial advice. If you would like to learn more click on the HMRC link below:

Tax on a private pension you inherit – GOV.UK (www.gov.uk)