One of the brilliant things about saving into a pension is that you get tax relief on your contributions. And while there are certain limits and rules that govern this tax relief, it’s not as complicated as it seems.
1. Why invest in a pension?
Saving into a pension means putting aside money to support yourself in later life, once you’ve stopped working. Since a pension is usually opened around 20 to 30 years before you retire, it has time to grow during your working life. The money you save into your pension is usually invested in a range of assets, in the hope that it will increase in value.
The government encourages pension saving by providing tax relief. In practice, this means that your pension is topped up by HMRC, helping to leave you with a bigger pension pot at retirement.
When you reach retirement age, you can take 25% of your pension savings tax-free. The rest is taxed as income.
If you die before the age of 75, you can pass your pension on tax-free to your beneficiaries. If you have a PensionBee pension, you can set up your beneficiaries in the account section of the BeeHive.
2. How does tax relief work?
If you’re under the age of 75 and you have UK earnings (or you’re a UK resident for tax purposes) you can contribute to a pension and receive tax relief.
• Personal pension contributions are eligible for tax top ups, while employer contributions aren’t. You need to declare that you’re eligible for tax relief when you open your pension plan.
• If you have a PensionBee pension, when you make contributions we will automatically claim your 25% tax top ups from HMRC. This money will be added to your account, and you can track it from the balance tab in your BeeHive.
• If you’re a basic rate taxpayer, this is all the tax relief you get. If you’re a higher rate taxpayer or an additional rate taxpayer you can claim further tax relief via the Self Assessment tax process, in just a few simple steps.
3. How do company contributions work?
Company directors can make contributions to pension schemes (including their own), and these will be treated as an allowable business expense as long as they are reasonable.
This means that the pension contribution isn’t treated as part of the company’s profit, so 20% corporation tax doesn’t have to be paid.
The company and the employee also save on National Insurance Contributions (NICs), which would be due if the money was paid as salary instead.
Employer contributions aren’t ‘topped up’ by tax relief. This means that PensionBee won’t claim tax relief on employer contributions.
Since tax calculations and tax rules can be complicated, we suggest you speak to your accountant for advice.
4. How much can I contribute to my pension?
There are limits that restrict the amount you can contribute to your pension each year and still receive tax relief. If you exceed these limits, you’ll usually have to pay tax charges.
The basic rule is that you can make pension contributions up to the level of your ‘relevant UK earnings’, or up to £3,600 if you’re not earning anything.
It’s usually your salary that counts as your ‘relevant UK earnings’, so the figure doesn’t include dividends, rental income, interest, capital gains etc.
But pension contributions also shouldn’t exceed your annual allowance. For most people, the annual allowance for 2018/19 is £40,000.
There’s also a tapered allowance for high earners. This will affect you if you earn more than £150,000 including employer pension contributions (called your ‘adjusted income’), and more than £110,000 excluding pension contributions (known as your ‘threshold income’).
For every £10,000 you earn over £150,000 (adjusted income), your pension contribution limit reduces by £5,000, down to a minimum annual allowance of £10,000 if you earn £210,000 or more.
You can also ‘carry forward’ any unused annual allowance from previous years, as long as you were part of a pension scheme during those years. However, your maximum contribution may still be limited by the earnings limit.
Both personal and employer contributions count towards your annual allowance, including tax relief on personal contributions.
Company contributions can exceed your earnings, but they are subject to the annual allowance.
Laura has an annual salary of £75,000, so her annual pension contribution limit is £40,000. Her employer contributes £10,000, so her annual limit for personal contributions is £30,000. This means that Laura can pay in £24,000, as her tax relief of £6,000 will bring her total contribution up to £30,000.
Please note that we can’t make individual calculations for customers, so you should speak to your accountant for advice.
5. How much should I contribute to my pension?
It can be difficult to decide how much to pay into your pension. As well as the tax relief limits, these are some other things to think about:
• Gross vs. net contributions
Remember that the amount you pay into your pension is a net amount, because it will be topped up by the tax relief that your pension provider will claim from HMRC. This means that if you want to add £125 to your pension, you can pay in £100, because £25 will be added through tax relief.
• How much you want to get at retirement
The other factor to think about is how much money you want to have when you retire. It can be difficult to figure out the relationship between the amount you pay in now and the income you can expect at retirement, but if you play with our pension calculator that should help you.
• How much people pay on average
PensionBee customers pay on average around £240 net (£300 gross, once tax relief has been added) into their pension each month. Many also make one-off pension contributions to maximise their tax relief allowance.
6. What is the lifetime allowance?
As well as the annual allowance, there’s a lifetime limit on pension contributions. The lifetime allowance has recently been lowered to £1 million, but it will increase to £1,030,000 from 2018/19.
If your pension exceeds the lifetime allowance, you may have to pay a tax charge.
Some savers with pensions over £1 million can get protection from the reduction in lifetime allowance, especially if you were saving when the limit was higher. You need to apply to HMRC for this protection.
7. How does it work when I want to take the money out of my pension?
Currently, you can’t access your pension money until you reach the age of 55. The only exception is if you’re very ill, with a life expectancy of under 12 months.
After the age of 55, you can take up to 25% of your pension pot tax-free.
The rest of your pension pot is subject to income tax, and can be accessed (‘drawn down’) flexibly.
Once you begin taking taxable income from your pension, the amount you can contribute to your pension and still benefit from tax relief is reduced. You’re subject to a lower limit, called the ‘reduced money purchase annual allowance’, which is £4,000 for 2017-18.
Is there anything else you need to know about pensions? Ask us in the comments at the bottom of the page.