4 important tax rules that could help you boost your pension before retirement
The last few years of work before you retire offer a fantastic opportunity to boost your pension pot. Often, this is the time when you have more funds available, whether that’s because you’ve reached your maximum earning potential, paid off your mortgage, or because your children have flown the nest and become financially independent.
With this extra money now in your pocket, investing it into your pension could be a sensible way to boost your retirement income. By making the most of some of the tax rules surrounding pensions, your money could go even further.
Read on to discover four tax rules that could help you to grow your pension pot ahead of your retirement date.
1. Tax relief on pension contributions
You will usually receive tax relief on pension contributions at your marginal rate of Income Tax.
If you're a basic-rate taxpayer, you'll benefit from 20% tax relief on your contributions. So, a £100 pension contribution only "costs" you £80.
For higher- and additional-rate taxpayers, the tax relief is even greater: 40% and 45%, respectively.
While basic-rate tax relief is applied automatically, if you pay a higher rate of tax, it’s important to claim the additional tax relief back on your self-assessment tax return or by contacting HMRC.
Here’s a working example of how the tax relief on your contributions can help you to grow your pension pot in your final years of working.
Clive is a basic-rate taxpayer who has one year left until he retires. Having recently paid off his mortgage, he now has an additional £675 to spend each month, since this was the value of his monthly repayments.
If Clive chose to invest this amount into his pension, with the added tax relief from the government he’d be depositing a total of £844 a month to the pot.
Over the course of 12 months, this would amount to an investment of just over £10,000 into his pension at a cost to Clive of just £8,100. On top of this, Clive may also benefit from employer contributions or investment returns, although these cannot be guaranteed.
2. The abolition of the Lifetime Allowance tax charge
In previous tax years, if your combined pension savings exceeded the Lifetime Allowance (LTA), you may have incurred an additional tax charge when you came to access the funds. In the 2022/23 tax year, the LTA was £1,073,100.
The chancellor has announced that there will be no tax charge for exceeding this amount in 2023/24, and he plans to abolish the LTA entirely from April 2024.
This means that there is no maximum threshold above which you could incur a penalty for withdrawing from your pension funds. Given the tax efficiency that pension saving offers over alternative wrappers such as a cash savings account, investing as much as possible into your pension in your final years of working could prove to be beneficial.
An important side note to this is that the maximum pension commencement lump sum (PCLS) – the amount that you can withdraw from your pension tax-free – will be frozen at its current level of £268,275 (25% of £1,073,100).
So, no matter how large your pension pot is, you will only be able to withdraw a limited amount tax-free from 2023/24. The only exception to this is if you have Lifetime Allowance protection, which enables you to take a percentage of a higher value pension pot tax-free.
3. The Annual Allowance and “carry forward”
The Annual Allowance limits the amount of pension contributions you can make each year before an additional tax charge becomes payable. In 2023/24, the Annual Allowance is £60,000.
That said, it may be possible to contribute more than this in a single tax year – if you have any unused allowance from the previous three years, “carry forward” allows you to contribute this amount once you have used up your Annual Allowance for the current year.
If you have unused allowances from multiple years, you’ll need to use the earliest year first.
Higher earners may be subject to the Tapered Annual Allowance
If you earn a high salary, you may be subject to the Tapered Annual Allowance. This applies to individuals who earn:
A “threshold income” of more than £200,000 AND
An “adjusted income” of more than £260,000.
Your threshold income will usually include your net income including salary, bonuses, rental income, and dividends.
Meanwhile, your adjusted income adds the value of employer pension contributions to your income.
The taper will only apply to you if you meet both of the above criteria. In this case, your Annual Allowance will reduce by £1 for every £2 of adjusted income that you earn over £260,000. The minimum Annual Allowance in 2023/24 is £10,000.
You must account for the taper if you were subject to it in the tax year that you are carrying forward from.
4. The pension commencement lump sum
While most pension income above your Personal Allowance will be taxed at your marginal rate of Income Tax, you can usually withdraw the first 25% of your pension pot tax-free.
You could withdraw this as one lump sum, or, if you’d prefer to take a number of smaller lump sums, 25% of each one will be tax-free with the remaining 75% taxed at your marginal rate.
This rule means that you could spread your pension withdrawals over several tax years, reducing the amount of tax you pay in those years. This could help your pension savings to go further, giving you more opportunities to enjoy the retirement lifestyle you’ve been dreaming of.
Get in touch
If you’d like to speak to someone about how to save enough for the retirement you’d like, we can help.
Email info@informedpensions.com
Call 0880 788 0887
Please note:
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The Financial Conduct Authority does not regulate tax advice.