As I wrote recently, there’s plenty you can do before the tax year ends at midnight on April 5, if you act fast.
Along with the tax planning steps I highlighted in that article, most of us also have a secret weapon. It can deliver big tax savings and even knock people into a lower income tax bracket. It’s called your pension.
Pensions have multiple tax advantages. First, contributions attract tax relief. Second, money grows free of tax until you start making withdrawals.
Third, you can take 25% of your pot as tax-free cash, though income tax is charged on the remainder.
Pension savers who die before 75 can pass on unused pots free of income tax. Thereafter, beneficiaries pay income tax on withdrawals.
A fifth benefit is set to expire in March 2027 when Reeves plans to scrap the inheritance tax exemption on unused pension pots. This will be a blow if it goes through.
Despite that, the case for investing in pensions remains strong, said Emma Sterland, chief financial planning director at Evelyn Partners.
“With personal and higher-rate tax thresholds frozen until 2028, almost everyone will pay more tax as each year passes. Pension saving is one of the few ways to mitigate income tax and keep more of your earned income.”
Here’s how.
If the income tax threshold freeze has pushed you into a higher income tax band, making a pension contribution before April 5 could push you back below.
As well as saving tax, this will also protects your personal savings allowance (PSA), the amount of savings interest you can claim each year before paying tax on it.
The annual figure is £1,000 for basic rate taxpayers, then halves to £500 for higher rate taxpayers and disappears altogether for additional rate taxpayers.
Making a pension contribution can protect that.
Pension contributions attract tax relief at your marginal rate – either 20%, 40% or 45%, depending on your tax bracket.
There’s speculation that Reeves could cut them to a flat rate of just 25% for everyone, in her upcoming Spring Statement on March 26.
She probably won’t dare but it’s still worth taking advantage of higher rate pension tax relief just in case.
Sterland said making extra contributions may tempt those with lump sums sitting in bank accounts. “Particularly older savers keen to play catch up or boost their pot before retirement.”
Company pension scheme members, or workers with access to salary sacrifice, could raise their monthly contribution or pay in a lump sum. Discuss this with your payroll department or HR.
Employers might even agree match your extra contributions. They now have an incentive to do so, as they will save on April’s hike to employer’s national insurance.
Anyone expecting a bonus should consider sacrificing some or all that into their pension. “That way, they keep their full payout rather than losing a large proportion to tax and NI,” said Sterland.
Employees should move swiftly, as payroll or HR need advance notice.
Under the annual allowance, everyone can save the equivalent of 100% of their earnings in a pension, up to a maximum £60,000.
They can pay more, but excess contributions won’t get tax relief.
Earnings include income from employment or self-employment, certain redundancy payments and income from a commercial furnished holiday lettings business.
Pension income, stock dividends and other rental income don’t count. If you earn less than £60,000, your annual allowance falls accordingly.
If you’re 55 or over and have started making pension withdrawals, the allowance falls to just £10,000 under the money purchase annual allowance (MPAA).
If you can tuck away more than £60,000 in a pension, there’s a little-known tax break you can use.
Under so-called carry forward rules, you can also mop up any unused annual allowance from the last three years.
This can be useful for people wanting to invest an inheritance, someone who’s sold an asset or earned a bonus, or business owners with irregular earnings.
“Making a big one-off pension contribution using carry forward can be complex. A financial adviser can help avoid mistakes and issues with HMRC,” Sterland said.
Pension tax relief is open to tens of millions. But make sure you understand the rules.
Anyone is free contribute to a personal pension and claim tax relief, even if they have an active workplace scheme, Sterland said. “Personal pension providers add 20% basic rate tax relief automatically. However, you must claim higher 40% or additional rate 45% relief yourself from HMRC.”
Pension tax relief often sits unclaimed as a result. Forgetting to claim higher rate relief defeats the purpose of injecting a lump sum into a pension.
Savers must include higher-rate pension tax relief claims on their self-assessment tax return. Contact HMRC directly if you don’t usually file one.
Here’s another benefit that’s often forgotten.
It is also possible to claim tax relief on pension contributions made on behalf of a non-taxpayer such as a non-working taxpayer, spouse or even a child. The maximum is £2,880, with 20% tax relief topping that up to £3,600.
That’s effectively a free £720, so well worth claiming.
Before investing extra sums into a pension, for any reason, there’s one thing to remember.
You can’t touch your pot until you turn 55, rising to 57 from 2028. So don’t invest money you may need for other purposes before then.
