There are many tax advantages to investing in a pension to fund your retirement, but there are calls to reduce some of the benefits of this long-term savings product, especially for higher earners.
A pension is a financial product that aims to provide “old age security”. Money Assistant.
Like an Isa, there are no taxes on investment growth, but you can only access it at age 55 to provide “income later in life if you want to work less or retire”, according to the Financial Guidance website.
In its spring budget in March 2023, the government also set out plans to change the rules on how much can be taken into a pension.
Support for pension savings through the tax system is also expensive for the state Institute of Fiscal Studies (IFS) is the latest to call for reforms, claiming that those who earn more are benefiting from “too generous subsidies”.
Pension tax benefit
If you save for retirement, said which one?the government likes to give you a bonus known as tax relief “as a way of rewarding you for saving for the future”.
Income tax is usually taken “at source” every month from the employee’s salary, he said Unbiasedbut pension tax credits actually give you that money back from every contribution you make based on your personal income tax rate.
The basic allowance of 20% is automatically added to your pension contributions, but “things are a bit more complicated” if you’re a 40% or 45% rate taxpayer, as you have to pay back an extra 20% or 25% – a tax return.
If you’re a basic rate taxpayer, Which? said, and had to contribute £100 of your earnings to your pension, “it’ll actually only cost you £80”, as the government adds an extra £20 on top – “which is would take tax out of £100 of your salary.’ Similarly, higher and additional rate taxpayers only need to pay £60 and £55 respectively to get the same £100 of pension savings.
However, pension tax relief is expensive for the government to fund, leading to rumors that the Treasury may reduce it for high earners. The very last HMRC figures show the value of pension tax relief in 2022/2023 was £27 billion.
There has been speculation for years that the government might be tempted to cut tax breaks to cut spending, Hargreaves Lansdown analyst Helen Morrissey said FT advisor “So far it has been resisted, but with budget pressures, it may prove to be too attractive a prospect to leave,” she said.
How much can you save for retirement?
You can currently put up to £40,000 a year into your pension, with a lifetime limit of £1.073m. Any contributions above the limit are taxed at 55%.
But Chancellor Jeremy Hunt said in his spring budget that he admitted the allegation was forcing senior NHS clinicians to leave the profession “just when they are most needed”.
A growing number of older people are in generous defined benefit pension schemes Guardianwere “faced” with a lifetime allowance or worried that it was coming soon, which could have deterred people from working longer.
To combat this and encourage people to stay in work if they can, from the new tax year in April the annual limit will rise to £60,000 and the lifetime allowance cap has been scrapped.
The chancellor went “much further than pre-Budget leaks which suggested he could raise the threshold to £1.8m”, said Financial Times.
There is a catch, however, as the maximum amount of tax-free cash that can be drawn from a pension will remain capped at 25% of the current lifetime allowance of £1.073m, the paper added, to a maximum of £268,275.
The IFS has argued in the past that the tax-free lump sum only benefits those with bigger banks and has “no value for those on the lowest incomes in retirement”.
“Hunt also solved another quirk in the system,” The Guardian said, which could force some older people back to work.
At the moment, someone aged 55 or over who was already drawing money from their defined contribution pension fund has the amount they can pay in a year reduced to just £4,000, known as money-to-buy annual allowance. “This particularly affects people who have taken early retirement,” writes The Guardian, “but perhaps because of the cost of living crisis, they would like to start working again and be able to continue saving. for retirement”. This will now rise to £10,000 in April.
How to reduce tax on pension
There may be no more penalties for contributing too much to your pension, but it’s a different story when you get access to your bank.
Once you retire, you have two main options: use a drawdown product that allows you to invest your pension while you can receive regular payments, or use a bank to buy an annuity product that pays a fixed income until the end of your life.
Whatever you choose, your pension benefits will be added to your total income, so the amount of tax you pay will depend on your total earnings for the year, apart from the personal allowance threshold of £12,570 for the 2022/23 tax year.
The best way to avoid paying too much tax on your retirement income is to only take what you need.
Using a drawdown scheme can help with that, he said Personal office, a firm of independent financial advisors. You can decide how much you withdraw based on your current budget and expenses, “meaning you can choose to have it below a certain tax bracket in a certain year.” This will not work with an annuity because “the income cannot be changed at will”.
You should earn as much income as you need to live comfortably, he said Unbiasedbut unlike earning a salary, “having more income than you need and investing it in savings has fewer advantages.”
In most cases, a financial website says, “it’s best to leave money in retirement until you’re sure you’re going to spend it.”
Mark Schoffman is an award-winning freelance journalist specializing in business, property and personal finance. He has an MA in Financial Journalism from City University and has previously written for FTAdviser, ThisIsMoney, The Mail on Sunday and MoneyWeek.