How much should I save into my pension? Save tax and boost your pension

A question posed to me recently by someone aged 41, with a modest personal pension provision. Pensions have been unloved by many for a lot of years, they are perceived as the Brussel Sprout of the finance world!

We focus on objectives – what do you want to do? Then think about how to fund those objectives. Pensions are part of the puzzle, like you would get for Christmas, and therefore the answer to such a question, will vary for each of us.  A bit of background….

There are three main types of Pension: Defined Benefit (DB – think a rare treat like Beef Wellington) and Defined Contribution (DC – the common turkey equivalent) and the State Pension.

• A DB pension will pay you an income for life when you retire. These are rare in the private sector but common in the public sector. (e.g. Teachers, Police, NHS etc)
• DC pensions are the ‘norm’, but require you to own, understand and take responsibility of managing your own pot of money.
• The State Pension has no bearing on your ability to save into a private pension. Remember, you need 35 years of national insurance credits to receive the New State Pension in full (worth around £10,600 from April 2023)

The following notes focus on DC pensions, as they’re more common and where individuals have responsibility for the outcome and contribution considerations.

How much can I put (stuff!) into a pension?

Two primary factors to consider. One is an annual allowance, the second, the lifetime allowance. You can technically contribute above these allowances, but there are tax consequences of doing so.

The annual allowance is £40,000, inclusive of tax relief. However, this may be reduced for a few reasons, for example if you don’t earn £40,000 or above, your annual allowance is limited to your earnings, if contributions are paid for personally. If you’re a very high earner, earning in excess of £240,000, your annual allowance may be reduced (tapered).

It’s important to be aware that earnings for the purpose of pension contributions, exclude income such as interest, dividends or buy-to-let rentals.

The lifetime allowance (LTA) is a little more straightforward.

The LTA is currently £1,073,100. That’s a lot of money, but if you’ve been saving into a pension for many years, you might find you’re closer than you think and also, if you’re fortunate enough to have a DB pension, that will add to your pensions from an LTA perspective.

If you exceed the LTA, your pension provider has to apply a tax on the excess, at either 25% if you’re taking the pension as an income, or 55% as a lump sum. I’d suggest it’s better to get 75% of something (in the income example), rather than 75% of nothing.

Can I use carry forward (seconds anyone)?

If you earn over £40,000, or your employer is paying contributions on your behalf, then you could potentially utilise un-used pension allowances from the previous 3 tax years. This has several benefits

• You’ll receive tax relief in the current tax year
• Your pension gets an even greater boost
• You’re building your financial provision for later life

It does not matter what you earned in those 3 previous tax years.

What about tax relief (the gravy on top of the dinner!)?

If you’re employed, you’ll have an employer sponsored pension, meaning between you & your employer, you’ll contribute to a pension and you’ll automatically receive the tax relief as part of the payroll process.

If you make contributions to a pension separately, the pension scheme will claim tax relief on your behalf, at the basic rate of tax. If you’re a higher or additional rate taxpayer, then you can claim further tax back from HMRC.

I’m always keen to try and remind people to utilise options and allowances available – get saving now and use those allowances and tax reliefs. If you wake up at age 55 and think about your pension then, you’re leaving it rather late.

I have my own limited company, what can I do?

The annual allowance applies, but not limited by your personal earnings. The company can contribute up to £40,000 per year into a pension for you and potentially more under carry-forward rules, subject to the contributions meeting HMRCs criteria.

So as a company owner, you’re in a potentially fantastic position to get your pension growing and save corporation tax for the company.

So how much should I save into a pension?

It’s not an easy question to answer but try and contribute as much as you can afford, without being a detriment to your lifestyle. If you’re a higher or additional taxpayer, remember, each £1 in your pension will cost you just 60p or 55p respectively. The gift of pensions!

Recap

• You can typically contribute up to the higher of your earnings or £40,000
• If you’re a basic tax rate payer – your tax relief is sorted
• If you’re a higher/additional rate taxpayer and you make personal contributions, you’ll need to claim some tax back from HMRC
• Pension contributions are tax efficient from a personal and company perspective

Have a look at your pension projection and information and take an interest, in your future.

We can help you understand your retirement provisions and plan for your future, so please do not hesitate to reach out for a chat. But in the meantime enjoy those Christmas dinners!