From declaring the child benefit charge to saving tax through salary sacrifice, there are a number of tax advantages and pitfalls when it comes to retirement saving - here are 10 devilish details all savers should know about.
The government's fiscal year is coming to an end next month and as savers scramble to make those last minute tax savings Adrian Lowery, personal finance expert at Bestinvest, and Louise Higham, chartered financial planner at Tilney, Smith & Williamson, have drawn up a list of benefits and dangers everyone should be aware of, this tax year and beyond.
"It pays to know about how pensions are treated by the taxman right through the saving journey and beyond retirement," said Lowery.
"Not least because if the UK’s public finances don’t improve then some of the tax reliefs may well be diluted in the future – just as personal allowances have been eroded and frozen in recent years."
1 Making the most of pension tax reliefs
Tax relief boosts the value of a pension pot immediately, so it cannot be ignored, said Lowery and Higham.
It is granted automatically at 20 per cent of the amount going into a pension, while higher-rate taxpayers can claim back an extra 20 per cent and additional rate taxpayers 25 per cent, whether that is through their annual self-assessment tax return or their workplace pension.
This means a higher-rate taxpayer is getting £100 in their pension for a net cost of £60 - a 66.7 per cent return before any investment growth.
However, workplace schemes vary in how they administer this, so some higher-rate taxpayers will have to take steps to claim back their extra tax relief.
2 Dropping a tax band by upping pension contributions
At some companies the tax benefits could be even greater as they may allow employees to reduce salary or bonus payments in lieu of increased pension contributions, the pair said.
So-called salary sacrifice entails the employee agreeing to a lower gross income and the employer paying the difference into a pension alongside their usual contributions.
Both employee and employer will as a result pay lower National Insurance contributions, which are set to rise in April.
Higham explained: "If you are close to the £50,271 earnings threshold where the higher 40 per cent tax rate kicks in, you could dip under it by using salary sacrifice pension contributions so you don’t end up paying excessive marginal tax."
But she warned there were disadvantages for some, such as affordability calculations when it comes to applying for a mortgage.
Employee benefits such as life cover, and holiday, sickness and maternity pay could also be affected, as could one’s NIC record and state pension entitlement in the long term.
3 Watching out for allowances
Savers who are able to lock away their money until the minimum pension access age should seriously consider any available tax advantages, but there are ceilings on what can be saved tax-free, the pair said.
There is the annual personal allowance of £40,000 (2021/22) for pension savings, as well as the tapered annual allowance affecting the highest earners, which can reduce the allowance to as little as £10,000.
Savers can also not contribute more than 100 per cent of their earnings to a pension during the tax year.
On top of this there is the lifetime allowance, which is currently set at £1,073,100 and frozen at that level until 2025/26.
4 Using carry forward for unused allowances
Pensions carry forward rules allow savers to use unused allowances from up to the three prior tax years in the current tax year - provided they have already maximised their current annual allowance and are still in the same scheme.
Tax relief would be applied at the saver's current marginal rate and so carry forward can be very attractive to someone whose earnings have risen significantly.
However, "it is worth noting that you are still limited to 100 per cent of your salary in the tax year you are making the contribution, regardless of how much you have available from previous allowances," said Higham.
5 Accessing pensions tax-free
From pension access age, currently 55, up to 25 per cent of a pot can be accessed tax free – with the remaining 75 per cent available as taxable income.
This option is not suitable for everyone but could suit some under the right circumstances.
6 Triggering the money purchase annual allowance
Those planning to access their pensions flexibly need to think carefully about both the tax impact and the effect it will have on their ability to save further amounts into pensions in the future, warned Lowery and Higham.
Under current rules, introduced to stop the recycling of money through pensions, anyone who makes a flexible withdrawal from their retirement pot beyond the 25 per cent tax-free lump sum triggers the 'money purchase annual allowance'.
This permanently cuts their annual allowance from £40,000 to just £4,000, and revokes the privilege to carry forward unused allowances from previous tax years.
7 Reclaiming overpaid tax on pension freedom withdrawals
When taking a flexible payment from a pension, HMRC assumes it is just the first of 12 monthly withdrawals. As a result it is likely to be taxed at an emergency rate and will probably mean significant overtaxation.
Taxpayers can get this money back through their self-assessment tax return, or by applying to HMRC.
8 Declaring the high-income child benefit tax charge
If a taxpayer or their partner has claimed child benefit, and one of them earns more than £50,000 a year, they will be liable for the high-income child benefit tax charge.
This needs to be paid through self-assessment and increases the more the person earns. Above £60,000 it equals the total amount of the child benefit.
This means lots of people choose not to claim child benefit, said Higham, but by not claiming, they might miss out on National Insurance credits that count towards state pension entitlement.
"The sensible option is to register for child benefit but opt to not receive it. So you don’t have to pay the tax charge but still accumulate NI credits," said Higham.
The charge could also be avoided by using salary sacrifice to take gross earnings below the £50,000 threshold.
9 Nominating a beneficiary
Pensions are an important part of tax and inheritance planning.
If a person dies before age 75 their fund can be passed on to their beneficiary tax-free, while if they die after 75 it is taxed in the same way as income.
It the beneficiary dies before age 75 they too can pass on any untouched funds tax-free - even if the original benefactor died after age 75.
"If no death benefit nomination is completed then your beneficiaries would only be able to receive your pension benefits as a lump sum," said Higham.
"This can lead to quite a significant tax charge for your loved ones if anything happens to you after age 75.
"Nominating a pension beneficiary is usually something that can be done in a matter of seconds online and can result in a massive tax saving for your loved ones."
10 Claiming relief as a non-taxpayer
Non-taxpayers can get tax relief. This includes a spouse who isn’t employed who can still pay into a pension and receive 20 per cent tax relief.
In this case, the ceiling on annual pension saving is £3,600, made up of a personal contribution of £2,880 and the taxman’s contribution of £720.
carmen.reichman@ft.com
