This is one of the most FAQ we have been asked at RNS over the past 12 months.
With frozen tax allowances and increased awareness of pensions in general, it is not surprising that it has been such a popular query.
However, perhaps the question should really be: “Are you making tax efficient pension contributions?”
Pension contributions can be one of the best ways to save tax and there are there are lots of hidden opportunities that you may be missing.
Paying a premium into your pension each month is the most popular way of pension saving, however there are lots of other ways to use pensions and save tax.
As well as monthly premiums you can make one off lump sum pension contributions into qualifying schemes.
The contributions will usually qualify for a 20% tax credit, and often also additional income tax reliefs on top.
Child benefit
If you are losing child benefit because you earn over the clawback threshold a pension contribution lowers your taxable income, and could help you re-qualify for child benefit.
In addition, the pension contributions should qualify for income tax relief too, which could save up to another 40% tax.
Planning point – child benefit starts being gradually withdrawn when your income exceeds £60,000.
Junior pensions
People may be familiar with Junior ISAs, whereby you can pay up to £9,000 a year into a tax-free ISA for your child or grandchild until they are 18.
But you can also pay up to £3,600 a year into a Junior pension.
The good thing about this is there is a 20% tax credit added to your payment immediately.
So, to invest the full £3,600 you only need to pay £2,880 and the government adds a £720 tax credit to the account; an uplift of 25%.
Spouse's pensions
If your spouse is a director or shareholder in your business, they could be eligible to receive pension contributions from your business as part of their remuneration.
These pension contributions would usually be a tax-deductible expense for your business.
Even if your spouse doesn't work in your business there might still be an opportunity to pay pension contributions of £3,600 which would benefit from a 20% tax credit from the government of up to £720; an uplift of 25%.
40% tax trap
Earnings over £50,271 are usually subject to 40% income tax.
So, if you have had a bonus, a promotion, a pay rise, a new company car, or a good year in your business with higher profits, keep in mind that you might be moving into higher tax brackets by the end of the tax year.
Therefore, increasing or making one off pension contributions offsets against your earnings, gets a 20% tax credit, and brings your income tax rate back down again saving a further 20% in tax.
Example
£8,000 pension contribution paid = 20% tax credit added to your pension + £2,000 = 20% additional income tax relief personally + £2,000
Effective cost of getting £10,000 into your pension to you is £6,000; an uplift of 66%.
60% tax trap
If you earning over £100,000 then you can start to lose your £12,570 income tax free personal allowance.
This can result in an effective income tax rate of 60%.
A pension contribution lowers your taxable earnings and can start to reinstate all of your tax-free allowances saving you up to 60% tax.
Rental incomes
If you have buy to let property as part of your retirement plan, are you managing the tax on the rental income efficiently?
Rental incomes can sometimes be taxed at up to 40%, if there haven't been other qualifying expenses to set against them.
So, if you don't need the rental profits now, you could recycle them into pension, and receive a credit for any tax that would have been due.
Then in retirement as well as a buy to let income, you could have a pension income as well.
Conclusion
It is clear from the examples that there are numerous factors to consider when it comes to your pension, aside from the basic principle of your pension being a savings pot for your retirement.
Pensions remain a powerful tax planning tool which your RNS contact will be happy to discuss.