The new Chancellor, Kwasi Kwarteng, delivered his ‘Mini-Budget’ on 23 September, with changes to income tax amongst the measures announced. This will have an impact on pensions, and specifically your pension contributions next year.
If you’re a basic rate taxpayer in England and Wales, you’re currently paying 20% income tax, so 20 pence for every pound you earn above the personal allowance. From April 2023 that rate will drop to 19%, so you’ll be paying one pence less per pound. This will apply to anyone with annual earnings between £12,571-£50,270.
There are no changes to the higher and additional rate tax bands at this time, although if you’re a higher or additional rate taxpayer then you’ll also benefit from the 1% tax reduction on the portion of your earnings in the basic rate band. The higher rate income tax of 40% will continue to apply to anyone earning between £50,271 and £150,000. And following a government reversal 10 days on from the initial Mini-Budget announcement, the planned abolition of additional rate tax of 45%, will no longer go ahead. This means anyone earning over £150,000 will continue to pay the top rate of income tax. It’s worth remembering that income tax isn’t paid at the same rate across all of your income. It’s only paid on the portion of your income that falls within a tax band.
Overall, in the 2023/24 tax year, it’s expected that basic rate taxpayers will save £130 in income tax while higher rate taxpayers will save £360. These savings also apply to anyone withdrawing taxable income from a pension.
Changes to pension tax relief
Private pensions enable most savers to receive tax relief on their personal contributions corresponding with their rate of income tax. Therefore, if your income tax rate drops, the amount of tax relief you get from your savings will also drop. Basic rate taxpayers currently get 20% tax relief. In practice this means if you wanted to add £100 into your pension you’d only need to pay in £80 and HMRC will add the rest. When the rate reduces to 19% you’ll need to pay in £81. However, those saving into ‘relief at source’ pension schemes, such as those used by PensionBee, will continue to receive tax relief at 20% until April 2024.
Whilst the basic rate of tax relief is usually automatically added to pension contributions, additional and higher rate taxpayers will need to claim further tax relief by submitting a Self-Assessment tax return. Alternatively, they can contact HMRC directly.
If you can afford to, you may want to consider raising your pension contributions before these new rules come into effect in April 2024 to make the most of the tax relief currently available. If you’re thinking about doing so, it’s important to keep your annual allowance, which is up to £40,000 for the tax year (2022/23), in mind - you’ll be liable to pay tax on any amount over this limit. However, if you’ve any unused annual allowance from the previous three tax years, this may be a good opportunity to maximise tax relief on contributions you make before April 2024 using the pension carry forward rule. If you’re unsure of what your limits are, you may wish to speak to a tax consultant.
Changes to IR35 rules
It was also announced that the government plans to repeal IR35 rules. If you were one of the many people who were classified as ‘employed’ and brought on to an employer’s PAYE payroll as part of IR35’s implementation then this might be relevant to you. As part of this arrangement your employer would likely have auto-enrolled you into a pension scheme and provided contributions along with yourself and tax relief from the government. If you’re considering reverting to a contractor style arrangement as a result of the IR35 changes then it’s important to remember that you’ll once again be responsible for sorting out your own pension, although there may be tax advantages in doing so.
Pensions, and indeed, tax, can be complex to understand let alone keep up with how changes in policy affect them and therefore your finances. Our Pensions Explained articles are designed to help you understand everything you need to know in an accessible way. Plus, you may want to check back here on our blog as we regularly update it with news and information on how your pension’s affected by recent events. We’ll be sure to keep you informed if there are any further announcements which impact your pension.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.