The end of the tax year comes with a number of responsibilities. You need to think about your tax returns and consider your annual allowances. Another important consideration, however, is making your pension contributions. This article will consider these, answering a number of questions to quell any confusions or hesitancy, and help ease the process when making these contributions.
How do pension contributions work?
These contributions apply to auto-enrolment pensions. You will be automatically enrolled in a pension by your employer if you fulfil certain eligibility requirements as an employee. These standards include being over the age of 22, working in the UK, and earning over £10,000 a year. If this applies to you, then you are automatically enrolled to make minimum pension contributions every year. These come from three sources: you, your employer, and the government. The input has to encompass 8% of your earnings at a minimum, with your employer contributing, at the least, a minimum amount, normally around 3%, while the government will offer some tax relief. You are then required to make up the shortfall, ordinarily around 4%.
It is important to note that that these contribution requirements only apply to your qualifying earnings. This refers to limits set by the government in regard to your gross income (income before paying income tax and national insurance), to assess the minimum contribution that needs to be made by your employer. Your employer is required to pay 3% on any money you earned above £6,240 and below £50,270. Thus, if you’re earning £20,000 annually, you employer will need to make contributions based on £13,760 of your income, but if you’re earning £50,270 or more, they will need to at a minimum apply the 3% to £44,030. Many corporations will pay more than this, however, depending on your contract and their financial abilities.
Assess how much you need in your pension.
When you are contributing to your pension, it is important to consider how much you actually wish to have on an annual basis once in retirement. A modest retirement sits at around £23,000 p.a., allowing for your basic needs, as well as the possibility of a yearly holiday and a few luxuries. A more comfortable retirement lies at around £37,000 p.a., allowing for multiple trips as well as more disposable income, for instance for clothing, meals out etc. If you work in the UK, you will be able to rely on a state pension. However, a full state pension currently lies at around £10,000 annually, meaning you will require private pensions to make up the difference. You will need to, based on your annual income, assess how much you have to contribute every year to achieve your desired retirement income.
A few words on allowances.
It is important to consider that there are, as briefly mentioned above, specific limits to how much you can contribute tax- free to your pension, namely the annual and lifetime allowances.
The annual allowance currently sits at £60,000, with this being how much you can contribute to your pension in a given year before you are required to pay tax on your contributions. The £60,000 isn’t fixed though, and may be reduced if you are a high earner. The maximum you can earn before it is tapered is £200,000, your threshold income. After this, anything you earn above your adjusted income (threshold income + £60,000 allowance) reduces your allowance. Your allowance will be diminished by £1 for every £2 you earn above £260,000, up to a minimum allowance of £10,000.
The lifetime allowance refers to the maximum total you can have in your pension, while still enjoying tax benefits. It currently sits at £1,073,000. The charges applicable to contributions above the limit depend on when you took your savings. If you took them prior to April 2023, a 55% life allowance charge will be applicable if you took them out as a lump sum, or 25% if you took them out in a different way. Post-April 2023, you will be subject to income tax on some or all of the lump sum. It is important to note, however, that the government plans to abolish the lifetime allowance by April 2024.
How to build your pension up effectively.
The best tip for building up your pension is simply trying to put as much money into it as possible. As bland as that sounds, there are some actions you could take to achieve this. You could look if your employer is willing to contribute more. Often if you contribute more, your employer will seek to match this, but this isn’t necessarily a given. Further, you should look to start saving as early as possible. You can open a pension from the time you are sixteen, and will be automatically enrolled in a workplace pension from 22. Starting as early as possible lets you get into good saving habits early on, and gives you more time to amass your retirement savings. Finally, look to make voluntary contributions whenever you can. If, at the end of the month, you have left over disposable income, consider putting it into your pension, rather than buying that pair of shoes or putting it into that holiday. It may sound boring, but you will thank yourself once you hit retirement age.
Talk to one of our expert financial advisors today, to discuss your pension planning and achieving your ideal retirement outlook.