Tax breaks in your pension

Many people are used to saving money in a bank account or ISA. When it comes to retirement however, saving in this way won’t leave you in the best position you could possibly be in when you wave goodbye to the 9 to 5.

Pensions are the best tool for saving for those later years. They include a number of tax breaks that mean your money has more space to grow between now and when you retire. These benefits also give your savings a boost as well as helping out your beneficiaries. Let’s take a closer look.

Tax relief on pension contributions

Tax relief is a bonus from the government that helps to boost your pension pot, providing more financial security later in life. It is when the government gives you back the income tax you would have already paid on the money you are contributing to you pension. This means that your contribution is effectively made before tax.

All UK residents below the age of 75 can claim tax relief. And in most cases, you don’t even have to claim it yourself. It is claimed for you by your tax provider at source. In other words, when you make a contribution, your pension provider will claim the tax relief for you and place it straight into your pension. Your pension provider will only claim the basic rate of tax relief (20%). So, if you are a higher rate taxpayer (40%) you will need to claim back the additional tax yourself.

Tax treatment depends on your individual circumstances and may be subject to change.

Tax-efficient growth on your investments

As I’m sure you know, the money you place into your pension gets invested. The return on this investment is what helps your pension pot grow to leave you with more money for your retirement. The growth that you receive from these investments is free of tax.

Typically, you get taxed on the return you gain from any investments made outside of a pension. This is why a pension is the strongest tool when saving for retirement.

When exploring the investments associated with your pension, it’s important to remember that past performance is not an indicator of future results and the growth you receive can fluctuate with the market.

Tax-free cash

Under current government rules, you are able to start withdrawing your pension from the age of 55. And the first 25% is tax-free. This means that you don’t have to pay any income tax when withdrawing this portion of your pension. Any withdrawals you make from your pension after the first 25% are subject to tax at your marginal rate.

Withdrawing pension money early isn’t right for everyone as it will leave you worse off in retirement.

Inheritance tax

If you have a defined contribution pension, you may be able to pass it on to a loved one without it being included in your estate. This means that there would be no inheritance tax to pay. It all depends on when you die.

If you pass before your 75th birthday, any private pensions you hold can be passed on tax-free. Your beneficiaries can spend the money as and when they want to without incurring a bill, providing they take it within two years.

Is there a limit to the tax benefits I can receive?

While there isn’t a limit to how much you can contribute to your pension, there is a limit on how much you can receive tax benefits on. This is your annual pension allowance and is 100% of your wages or £60,000, whichever is lower. This takes into consideration any contributions you make across all your pensions, any contributions from your employer and any tax relief amounts received. Any contributions above this amount will not receive tax relief.