Tax benefits of saving in a pension

Saving in a pension is a tax-efficient way of building up an income for retirement.

Tax relief
When you make a payment into your pension you receive tax relief from HM Revenue & Customs (HMRC). The effect of tax relief on pension payments over time can be considerable - the more you contribute, the more tax relief you can get, subject to HMRC limits. And the sooner you start contributing to a pension, the more potential your money will have to grow.

Even if you don't pay tax, you could still benefit from tax relief.

Tax-efficient growth
Your pension fund grows largely tax-free, which can help to boost the amount you have in your fund.

Tax-free cash
You can usually take up to 25% of your pension savings tax free (depending on your plan/scheme rules). The remainder of your pension will be taxed.

Remember that the value of a pension fund can go down as well as up and so you may not get back what you put in.

So how does tax relief work, and how much can you get?

Personal pensions
If you have a personal pension, your contributions are paid into a fund after your income has already been taxed. So, for example:

  • For every £80 you pay into an individual pension the taxman will add basic rate tax relief of £20.
  • If you pay above the basic rate of tax, you can also claim additional tax relief through your tax self-assessment form at the end of the tax year.

The tax relief on Stakeholder and Group Personal Pensions works in exactly the same way.

Company pensions
If you are a member of your employer's pension scheme, your contributions will be paid directly from your salary before it is taxed, giving immediate tax relief. The tax you'd normally pay to the taxman is invested in your pension instead.

This is the same if you also invest in an Additional Voluntary Contribution Scheme or a Money Purchase Pension Scheme.

If you have given up existing salary or proposed salary increases to make additional contributions through salary sacrifice, you will not get tax relief but you will save on income tax and national insurance contributions - as you are reducing your salary in exchange for pension contributions. If you exchange your salary for pension contributions this may affect any future state or salary-related benefits that you may be entitled to.

Tax relief limits

You can get tax relief on every penny you contribute, up to 100% of your annual earnings, with an upper limit of £40,000 (known as your annual allowance) in 2017/18. The government limits the amount that can be paid each year, to all pensions, before incurring a tax charge.  If you exceed this 'annual allowance' you may be liable to a tax charge and must tell HMRC through a tax return.

If your income exceeds certain thresholds in any tax year your annual allowance for pension savings in that tax year will be reduced – this is known as tapered annual allowance.

If you have flexibly accessed pension benefits on or after 6th April 2015 then your tax relief limits will be reduced. This is known as the Money Purchase Annual Allowance.

Further information on pension allowances can be read in this flyer. This is a complicated subject and you may wish to speak to a financial adviser or further information may be obtained from HMRC.

This is based on our current understanding of current tax legislation and HM Revenue & Customs practice, both of which may change without notice. The impact of taxation (and any tax relief) depends on individual circumstances.

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