How tax relief helps you to save for retirement


Hand putting money into a piggy bankAs you probably already know, putting money aside for the future is an important part of financial planning. If you want to have a comfortable retirement, you need to ensure you have enough wealth to support it.

According to a recent survey by Royal London, published in Money Marketing, one of the main reasons why many people don’t save enough is because they often don’t understand how pensions work. For example, the study found that less than half of people surveyed had an understanding of tax relief.

If you want to have enough wealth to support your desired lifestyle in retirement, it’s important to know how to maximise your pension contributions. Here is how tax relief can help you.

The amount of relief you get is dependent on how much tax you pay

In order to encourage people to save for retirement, the government offers tax relief as an incentive. When you contribute to your pension, some of the money that you would have paid in tax is instead transferred to your pension pot.

There are three levels of tax relief, which correspond to the amount of Income Tax you have to pay:

  • Basic-rate taxpayers receive 20% tax relief
  • Higher-rate taxpayers receive 40% tax relief
  • Additional-rate taxpayers receive 45% tax relief.

What this means is that when you contribute towards your pension, the government tops it up with an amount dependent on your tax band.

For example, let’s assume that you are a basic-rate taxpayer. This means that if you wanted to make a contribution of £100 to your pension, you would only need to put in £80, and the government would add an extra £20, corresponding to your tax rate.

Each tax year you can get relief up to a limit called the Annual Allowance

Tax relief can be an easy and valuable way of boosting your pension contributions, which is why it’s important that you make the most of your allowances. There are two main ones that you need to be aware of.

The first is the Annual Allowance, which is the amount that you can save into your pension each tax year (6 April to 5 April) while still being able to benefit from relief. In the 2021/22 tax year, this stands at £40,000 or 100% of your annual earnings, whichever is lower.

You can continue to pay into your pension once you hit this limit, but you would no longer be able to do so in a tax-efficient way. Any contributions over your Annual Allowance may incur a charge.

The “Annual Allowance charge” essentially claims back any tax relief you receive on contributions over this limit.

Furthermore, there’s another important rule to bear in mind when it comes to retirement. As you may know, you can access your pension from 55 (rising to 57 in 2028) but this can pose issues if you want to do so while continuing to save into your pension.

If you choose to continue working while taking benefits from your pension, you may be affected by the Money Purchase Annual Allowance. This will reduce your Annual Allowance down to only £4,000 per tax year.

The second limit that you need to be aware of is the Lifetime Allowance. In the 2021/22 tax year, this stands at £1,073,100 and covers the total value of your pensions. This includes your contributions, your employer’s contributions from your workplace pension, tax relief, and investment returns.

When you take benefits from your pension, the Lifetime Allowance will be applied. If the value of your combined pensions are greater than the limit, you may have to pay a charge on the value above the threshold. You may be liable for a tax charge of 55% of any excess taken as a lump sum or 25% of the excess if taken as regular income.

Working with a professional can help you to grow your pension effectively

As we’re sure you know, when it comes to making important choices, it’s crucial to be able to make an informed decision. This is why, if you want to ensure that you manage your wealth in the most effective way to save for retirement, you may benefit from seeking professional advice.

Working with a financial planner can help you to grow your wealth more effectively, ensuring that you put enough aside for a comfortable retirement. A planner can also make sure that you don’t exceed your allowances, making sure that you can save in a tax-efficient way.

Get in touch

Whatever age you are, there are always lessons that can be learned so if you want to brush up on your financial knowledge, get in touch. Please email or call 0115 933 8433.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.