Making the most of tax relief on your pension
Most of us pay into a pension, knowing that itâs the best way to secure an income once we stop working. Less widely recognised is that pensions are among the most tax-efficient ways of saving for the future, as you can receive tax relief on any contributions you make.
For those who are not working or who earn less than ÂŁ3,600 per year, itâs possible to make pension contributions up to that amount annually and receive income tax relief at 20% on our contributions. For other UK taxpayers, the rule for the current tax year (2016-17) is that youâll get tax relief on your pension contributions of up to 100%, or an annual allowance of ÂŁ40,000, whichever is lower.
Of course, youâre free to make higher contributions, but anything over and above these limits then becomes subject to income tax at the highest rate youâd normally pay.
What is tax relief?
Tax relief is when money that would normally go to HMRC as tax is diverted elsewhere instead. In the case of pensions tax relief, itâs returned to your pension fund. That is, you get to keep money that would otherwise go to government on the condition that itâs invested in your pension.
Currently, you can get tax relief on your pension contributions of up to 100% of your total annual earnings. This is given automatically if your employer takes pension contributions from your pay before tax is deducted, or alternatively if your pension provider claims tax relief on your behalf at a rate of 20% and invests it in your pension pot. This is referred to as relief at source and is what occurs for most of us.
Itâs important though, that youâre not getting this relief on more than 100% of your annual earnings, otherwise youâll have to pay it back to HMRC. Itâs your responsibility to ensure that this is the case.
Do I have to claim tax relief myself?
Not entirely. There are some circumstances where you may have to claim pension tax relief yourself. This is the case if you usually pay income tax at a rate higher than 20%, and your pension provider has only automatically claimed it on the first 20%. Equally, youâll need to do this if somebody else is paying into your pension fund, or if itâs not set up for automatic tax relief.
The annual allowance
An annual allowance is defined to ensure that the lowest paid get the maximum benefit from their savings. This means youâll only have to pay tax on your pension savings if youâre contributing more than ÂŁ40,000 a year, the current annual allowance.
There is flexibility though, and the great thing about the annual allowance is that it can be carried over from any of the previous three tax years. This means if you had a lean year when your savings fell short of the ÂŁ40,000, you can carry the difference across to a more prosperous year, allowing you to save more than the ÂŁ40,000 tax-free.
Can I still pay in once Iâm taking out?
Itâs possible to continue paying into a pension scheme once youâve started withdrawing money from it, but in this case the allowance drops down to ÂŁ10,000 per year. This drop applies from the first full tax year after you begin withdrawing.
What If I exceed the annual allowance?
In this case, youâll first receive notification from your pension provider informing you that this is so. Youâll then use the information provided when you fill in your self-assessment tax return. Fill in the âPension savings tax changesâ section and HMRC will work out how much you need to pay. Itâs worth remembering though, that you can still claim tax relief for pension contributions above your annual allowance.
Your 2016/17 Tax Guide – Find out more
As with most tax matters, tax relief and allowances on pensions can be extremely complicated and affect different people in different ways. Here at Expert Wealth Management weâve collated the basic information you need into our 2016/17 Tax Guide that can be viewed here.
