Investing in pensions is a crucial when preparing for retirement. You want to ensure that you can afford your desired quality of life and can enjoy yourself after years of hard work. Looking to find tax-efficient means to maximise your pension value is important to best enjoy your twilight years. This article will look at various steps and considerations you can take to best ensure you’re investing in your pensions as tax-efficiently as possible.

Allowances

In terms of contributions to pensions, there are two main limits you need to keep in mind, namely the annual and the lifetime allowances. These refer to the maximum amount you can contribute to your pension without them being liable to tax.

In terms of the annual allowance, the general rule is that you’re allowed to contribute a maximum of £60,000 a year before you will start to be taxed. There are exceptions to this, however, especially for higher earners, namely the tapered allowance. This is attributable to anyone with a threshold income over £200,000 or an adjusted income over £260,000.

For the sake of clarity, the threshold income excludes any pension contributions whereas your adjusted income includes all of them, including your employer contributions.

If you are above this threshold, your annual allowance will be reduced by £1 for every £2 of adjusted income above £260,000, stopping at a minimum allowance of £10,000 when your income hits £360,000 or higher. So if your annual adjusted income is £300,000, your annual allowance would be tapered to £40,000, whereas if your income is £340,000 annually, your allowance would be set at £20,000 annually.

The other consideration is lifetime allowances. This is quite an important factor to keep in mind, since a lot has changed recently. Previously, you had a lifetime allowance of £1,073,200, at which point their was tax for crystalising any benefits above this level. This has changed now, however, with the lifetime allowance being abolished as of April 2024.

There are now three different types of allowances to keep in mind which will be summarised as follows:

  • Lump Sum Allowance (LSA):
    From age 55 or 57 from April 2028, you can take up to 25% of your pension as a lump sum tax-free. The Lump Sum allowance is the total amount of money you can take tax free as a lump sum from your pension. It is the equivalent of the 25% of the old lifetime allowance, and is around £268,275 for anyone without Lifetime Allowance Protection. You will only need to pay tax if the lump sum you take is over this allowance.
  • Lump Sum and Death Benefit Allowance (LSDBA):
    This refers to the total amount of tax-free lump sums to can be paid to you and your lifetime over your lifetime. This includes the aforementioned £268,275 LSA as well as benefits for ill health prior to age 75 and death benefits which become payable in the event of your death to your beneficiaries. Your beneficiaries are the people who the pension is transferred to in the event of your death. This sits at £1,073,200 for anyone without Lifetime Allowance Protection.
  • Overseas Transfer Allowance:
    This refers to the maximum amount you can transfer tax-free into a qualifying recognised overseas pension scheme (QROPS). There are few more requirements specific to the QROPS in relation to which country you are transferring to, where you are moving from, and how long you keep your pension in the new country, which can be found here. Nevertheless, if you fulfil those criteria, you have an allowance of up to £1,073,200 that can be transferred tax-free. If not, you’ll be liable to pay 25% in taxes.

Lifetime allowance protection

The old lifetime allowance was originally introduced in 2006 and went through a number of changes between then and its abolishment in 2024. In order to protect against any adverse consequences that these payments might have, the government implemented a number of protection schemes. These were subject to application deadlines, the final one of which is the 5th April 2025.

There are two types of protection you can apply for. These are quite complicated schemes. The individual protection is available to is available to anyone as of the 5th of April 2016 had pensions with a value of at least £1,000,000. Your allowance then, instead of the £1,073,200 allowance, becomes either £1.25 million or that value that you had on the 5th of April 2016.

For the fixed protection there isn’t a minimum pension value. However, if you wish to apply for it now (or applied for it any time after the 15th of March 2023), you can’t have saved or built up any benefits since the 6th April 2016. If this is the case, you can apply for this protection which will afford you an allowance of £1.25 million.

Do note, however, you cannot apply for either of these protections if you have successfully applied to previous schemes.

Protection SchemeIndividual Protection 2016Fixed Protection 2016
Who is eligibleThose who had over £1 million of pension savings on 5th April 2016

No minimum pension value.

If you are applying after 15th March 2023, you can’t have saved into a pension since 6th April 2016.

How it works

Your lifetime allowance becomes the lower of either:

·        £1.25 million

·         Your pension value as of 5th April 2016

This will set your allowance at £1.25 million

 

Your Lump Sum Allowance will be 25% of your new allowance. As such, if you have Fixed Protection 2016 with your £1.25 million allowance, your new LSA will be £375,000 instead of £268,275.

How does tax relief on pensions work?

If you have workplace or stakeholder pensions, you may be able to get tax relief, increasing your savings. When you are making pension contributions, the government will top this up, based on your income tax bracket. There are two ways this can happen:

  • Relief at Source
    Here the government tops up your contributions.
    Your employer deducts the income tax from your earnings, and then sends your pension contributions to your pension provider. The pension provider will then claim 20% back from the government to supplement your contributions. If you are in a higher tax bracket you may be able to claim more relief.
  • Net Pay
    Here your pension contributions are calculated from your income before you pay any tax. Your employer then calculates your net earnings without the pension contributions.

Both systems come out to effectively the same outcome. Those who may wish to choose a specific method are those who don’t pay tax or who are in a higher tax bracket.

  • If you don’t pay tax, you should opt for the first method, as the second method would leave you without any tax relief.
  • If you are in a higher tax bracket, you should opt for the second method. If the first method is used, you will have to claim any tax relief over 20% yourself.

One should take into account that if you are in a workplace pension, it is your employer who chooses which method to use. If you have a personal pension, the relief at source method is used.

Putting this into practice, if you earn £30,000 a year and you wish to add a pension contribution of £5,000, the following would happen:

  • Under the first method, your employer would deduct 20% income tax from your overall pay, leaving you with a net income of £24,000. A pension contribution of £4,000 (£5,000 minus 20%) will then be submitted to your pension provider who will claim back the £1,000 the was deducted from your pension contribution from the government, meaning you have a contribution of £5,000 overall.
  • Under the second method, your employer will deduct your £5,000 pension contribution from your gross pay, and submit this to your pension provider. Your employer will then deduct your income tax from your remaining £25,000 gross income.

If you earn £120,000 a year and wish to contribute £5,000, the following will happen:

  • Under the first method, your employer would deduct 40% income tax from your overall pay, leaving you with a net income of £72,000. A pension contribution of £3,000 (£5,000 minus by 40%) will then be submitted to your pension provider who will claim back the £2,000 the was deducted from your pension contribution from the government, meaning you have a contribution of £5,000 overall.
  • Under the second method, your employer will deduct your £5,000 pension contribution from your gross pay, and submit this to your pension provider. Your employer will then deduct your income tax from your remaining £115,000 gross income.

However, these figures are still subject to the annual allowance of £60,000, plus any potential carry forward you have available.

When can I access my pensions

Workplace Pension

This will depend on the pension provider. You might be able to start withdrawing from it as early as 55 (57 from 2028), however, in most cases, it will be somewhere between age 60 and 65. One should note that if you do withdraw funds from it before the stipulated age, you will be liable for an unauthorised payment tax charge, which can be as high as 55%.

State Pension

There are different rules for private and state pensions. Currently, state pension age is 66, however, this will increase to 67 from 2028. In terms of how much you will receive, this rises year on year. As of the tax year 2024/25, it sits at £221.20 per week for those with 35 qualifying years, rising by 8.5% from the previous tax year.

The State pension rises in line with the triple lock, which refers to a system whereby the state pension rises in line with the highest of three possible options:

  • Inflation
  • Average Earnings
  • 2.5%

It acts as a safeguard for UK pensions, ensuring they rise in line with inflation at least. This is important as it means retirees retain their spending power throughout their retirement, which is important since this is a relatively long period. A state pension won’t be sufficient though for your retirement. You need to make sure that you build up your private and workplace pensions and the state pension should be seen as supplementary.

How does a salary sacrifice pension work?

If you are looking for more tax-efficient options, you could consider a salary sacrifice pension. This is where you agree to a reduction in your salary which is equal to your pension contribution. Your employer will pay the difference into your scheme, as well as their contributions.

The main benefit of this is more take-home pay. As your salary is reduced, you will pay less tax and less in National insurance contributions on your income.

There are a few caveats to this, however:

  • If your employer is providing you with life cover, this is usually calculated as a multiple of your salary. You might be worse off if your employer is calculating this based on pay after they have deducted your salary sacrifices.
  • If you’re looking to get a mortgage, a lower income will reduce your borrowing ability.

As a result, there are a number of considerations that can be made in looking to get your pensions as tax-efficient as possible. You need to look at how you can maximise your tax-relief, take advantage of any available schemes and systems that could aid you in doing this, while also being mindful of any pitfalls that could arise, for instance the allowances. Speaking to a financial advisor could help you establish the best route to take when looking to reduce your liabilities.

Talk to one of our expert financial advisors today

*This content of this blog does not constitute financial advice, and when investing your capital is at risk.

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