Can I get Tax Relief on Pension Payments?

What is a pension, and how does it work?

A pension is a financial product that lets you save up to fund your retirement. Technically, it’s a kind of tax wrapper with specific rules around what you can save and when you can access your cash.

There are broadly three types of pensions – defined contribution, defined benefit and the state pension.

Defined contribution:

Most workplace pensions are the defined contribution type. Private pensions, including Self-Invested Personal Pensions (SIPPs), are too. With this kind of saving, the amount you get when you retire depends on how much you contributed to your pension fund during your working life, your investment returns, and the charges you’ve paid.

Whatever you save attracts tax relief, which means the government boosts your contributions. If you have a workplace scheme, your employer usually has to contribute.

Your employer sets up workplace pensions, and you won’t get a choice over the provider. You should be automatically enrolled if you earn over a certain amount a year with one company. Those who haven’t enrolled automatically can usually register voluntarily because they don’t make enough or are under 21.

Defined benefit:

These are also sometimes known as final salary or career-average salary schemes. How much you get at retirement depends on your salary when you work and your length of service. You get a guaranteed income for life and don’t have to worry about investment returns.

State pension:

The state pension is a qualifying benefit paid by the government. To get the full amount, you need to have 35 years’ worth of National Insurance contributions. You can also get NI credits in some cases if you are out of work – for instance, if you’re looking after small children and have applied for child benefit.

Why pay into a pension?

Even though retirement can feel like a million miles away, saving early is generally a good idea. Most people want to retire at some stage, and you need enough money to keep you going, often for more than 30 years.  That means the cash you save while you’re working needs to last decades.

The more you put away when you’re younger, the more your investments will grow, and the more comfortable your retirement will be. Burying your head in the sand could mean you have to keep working past the point at which you’d like to slow down. The state pension only works out at £179.60 per week, which is less than most people need to live on.

While there are many ways to save and invest for your retirement, a pension is often the most attractive because you can get:

  • Tax relief (free government money). When you contribute to your pension, you get tax relief. In simplistic terms, this means that the government gives you free cash to top up your savings. Depending on how much income tax you pay, you’ll usually get added between 20% and 45%. There’s a limit, though; you can only save £40,000 a year or your total salary – whichever is lower.
  • Employer contributions (free money from your bosses). A workplace pension legally requires employers to contribute on your behalf. Not only do you receive contributions from the government in the form of tax relief, but you also get free cash from your boss. The minimum employers have to pay is 3%, but many will pay more if you increase your contributions. Ask your employer if they offer contribution matching.

Pension investments are free from the capital gains tax, so that you won’t pay tax on any profits made from the investments within your pension pots.

Pension 2028

  • Clarity is required for people who reach the new normal minimum pension age in 2028.
  • Real estate investment trust regime broadened.
  • Higher rates of tax relief for new theatrical and orchestral productions.
  • Reporting deadline for residential capital gains extended from 30 to 60 days.
  • Cross-border group relief inequalities removed.
  • Dormant asset scheme amended, so a tax charge arises only when the investor claims the asset.

Annual allowance charge:

You can only get tax relief up to your current annual allowance, made up of the current year’s allowance (currently £40,000) and any unused allowance from the previous three tax years.

Since April 2016, anyone whose total income, pension contributions and employer pension contributions are over £150,000 in a year will get a reduced allowance. However, it was announced in the Budget in March 2020 that the annual allowance will only begin to taper for those who have an income above £240,000 – the £200,000 allowance plus the £40,000 you can save into a pension.

It means that for every £2 of ‘adjusted income’ that goes over £240,000, the annual allowance for that year reduces by £1. Meaning anyone earning a total income of £300,000 or more will only get £4,000 tax relief annually.

This example shows how the annual limits can be used and carried over…

Current annual allowance = £40,000 (NB reduces to £4,000 if you’ve started taking money from your pension). You can top up your allowance for the current tax year with any allowance you didn’t use from the previous three tax years.

Say you have been investing £10,000 a year in a pension in recent years. You would then be able to carry forward three lots of £30,000 – a total of £90,000 on top of the standard £40,000 annual allowance. That’s £130,000 overall.

Normal pension age:

You are eligible for the state pension provided that you have at least ten qualifying years on your National Insurance (NI) record. A qualifying year means a year in which you earn over the Lower Earnings Limit as salary (dividends don’t count). How much you receive will also depend on how many qualifying years you have. You need at least 35 qualifying years to qualify for the full amount.

Do I need to pay NICs to qualify for the state pension?

You don’t need to have paid National Insurance Contributions (NICs) to qualify for the state pension, though usually, you will. To build up qualifying years, your salary must be at or over the Lower Earnings Limit (currently £6,136). However, you don’t start paying NICs until you take a salary over the NIC Primary Threshold (now £8,632). So if your salary falls between these two figures, you’ll build up qualifying years without paying any NI. For this reason, some company directors deliberately set their salaries at this low level and take the rest of their income as dividends.

How much is the state pension?

If you qualify for the full amount of the new state pension, you will receive £175.20 per week, or £9,110.40 a year (the tax year 2020/21). This amount rises each year, at least in line with inflation, and often more. If you have fewer than 35 qualifying years, the amount you receive will be reduced proportionally.

If you reached state pension age before 6 April 2016, you would receive the old state pension instead, a different amount.

How much can I earn while taking the state pension?

You can earn as much as you like and continue to qualify for the state pension. However, you will pay tax on any income above the personal allowance.

Here’s an example. The full new state pension gives you an annual income of £9,110.40. The personal allowance is £12,500, so you could earn up to £3,389.60 a year on top of the state pension before having to pay any tax at all. If you were to earn (for example) £10,000 a year while drawing the state pension, your taxable income would be £6,610.40, and you’d have a tax bill of £1,322.08 However, you wouldn’t pay any NI contributions.

If you’re still earning and drawing the state pension, talk to us at WIM accountants for financial advice to ensure you’re not wasting too much of your state pension in tax. It may make sense to scale back your hours or find another solution.

WIM Accountants are here to help businesses with their accounting and taxation needs.

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