Pensions can seem complicated, but the basic idea is a simple one. And increasingly, if appropriate, people are turning to private pensions as a tax-effective way to increase their retirement income. Once you’ve decided to start saving for retirement, you need to choose how you’re going to do it. The precise amount you’ll need to save each month to retire at 55 depends entirely on the kind of lifestyle you plan on having in retirement. If appropriate to your particular situation, there are several different types of private pension to choose from. But, in light of recent government changes, the tax aspects require careful planning.
Different pension schemes
The term ‘private pension’ covers both workplace pensions and personal pensions. The UK Government currently places no restrictions on the number of different pension schemes you can be a member of. So, even if you already have a workplace pension, you can have a personal pension too, or even multiple personal pensions.
These can be a useful alternative to workplace pensions if you’re self-employed or not earning, or simply another way to save for retirement. Any UK resident between the ages of 18 and 75 can pay into a personal pension – although the earlier you invest, the more likely you are to be able to build up a substantial pension pot.
Pension-related tax relief
A private pension is designed to be a tax-efficient savings scheme. The Government encourages this kind of saving through tax relief on pension contributions. In the 2018/19 tax year, pension-related tax relief is limited to either 100% of your UK earnings, or £3,600 per annum. If you are a Scottish taxpayer, the tax relief you will be entitled to will be at the Scottish Rate of Income Tax, which may differ from the rest of the UK.
Basic rate taxpayers will receive 20% tax relief on pension contributions. Higher rate taxpayers also receive 20% tax relief, but they can claim back up to an additional 20% through their tax return. Additional rate taxpayers again pay 20% tax relief, but they can claim back up to a further 25% through their tax return. Non-taxpayers receive basic rate tax relief, but the maximum payment they can make is £2,880, to which the Government adds £720 in tax relief, making a total gross contribution of £3,600.
Tapered Annual Allowance
The Annual Allowance is the maximum amount that you can contribute to your pension each year while still receiving tax relief. The current annual allowance is capped at £40,000, but may be lower depending on your personal circumstances.
In April 2016, the Government introduced the tapered annual allowance for high earners, which states that for every £2 of income earned above £150,000 each year, £1 of annual allowance will be forfeited. The maximum reduction will, however, be £30,000 – taking the highest earners’ annual allowance down to £10,000.
Overall tax liability
Any contributions over the annual allowance won’t be eligible for tax relief, and you will need to pay an annual allowance charge. This charge will form part of your overall tax liability for that year, although there is the option to ask your pension scheme to pay the charge from your benefits if it is more than £2,000. It is worth noting that you may be able to carry forward any unused annual allowances from the previous