Firstly, everyone benefits from paying into a pension because of the tax relief you receive on your contributions. The amount of tax relief on pension contributions you receive depends on your tax rate, which is based on your income and employment status and where you live. For most of the U.K. income tax rates are 20%, 40%, or 45% for the 2023/24 tax year, so tax relief mirrors these rates.*
However, because of the complexities of the tax system, it is possible to achieve tax savings of:
- 60% as a higher rate taxpayer where you have income between £100,000 and £125,140
- Almost 61% if you earn between £50,000 and £60,000 and receive child benefit for two children
- Up to 26.5%. corporation tax and up to 39.25% dividend tax saving if you own a limited company
Let’s explore some of these scenarios where paying into your pension can have significant tax benefits.
1. Tax savings available for those earning over £50,000 and receiving child benefit
If you or your partner earns over £50,000, the government reduces your child benefit. This reduction is called the High Income Child Benefit Charge.
The charge gradually increases between £50,000 and £60,000 and when you earn £60,000 the charge you'll pay back is 100% of your entitlement, meaning you won't get any benefit.
The amount you need to repay is calculated at a rate of 1% of the maximum child benefit for every £100 you earn over £50,000. Therefore, if you earn £55,000 a year, you will need to pay back 50% of your child benefit.
The benefit payment decreases between £50,000 and £60,000. For example, if you have a salary of £51,000 you lose 10% of your child benefit which would be £207.48 for two children, £290.16 for three children.
The Financial Times recently reported that thousands of parents have been subject to unexpected penalties due to failing to notify HMRC in relation to the High Income Child benefit tax charge. Over 6,500 parents have been issued with a penalty as they receive £50,000 or more in income due to wages going up or increased saving income due to rising interest rates.
By contributing to the pension, you reduce your taxable income, resulting in less loss of child benefit. Then you add on the 40% income tax relief and you end up with a larger tax saving amount.
To further illustrate this, if you have two children and an income of £57,000 and you make a pension contribution of £7,000, your total tax saving would be (7,000 x 40% = £2,800) + (7 x 207.48 = £1,452). This is a total saving of £4,252 which means that your £7,000 pension investment has only cost you £2,748.
2. Earning over £100,000, reduce your tax bill
If you are a higher rate taxpayer and your earnings exceed £100,000, your personal allowance decreases. Personal allowance is the amount you can earn before paying income tax, currently £12,570. A pension contribution gives you 40% tax relief and reduces the amount of tax-free personal allowance lost. The combined effect is often a 60% tax saving, meaning it costs you £4,000 to make a £10,000 contribution to your pension pot.
3. Are you a Limited Company director? Boost your tax efficiency by contributing to your pension through your company
If you own a company, having your company pay your pension contributions could be a wise choice. Contributing to a pension can reduce your tax liability through reducing your corporation tax bill. Corporation tax rates are 19%, 25%, to 26.5% (or a combination thereof), so this deliver a be a significant tax saving. Furthermore, many directors take profits as dividends. Contributing to a pension is another way to save on dividend tax because if you put the money into a pension you won’t be taking it out as a dividend. This gives another tax saving of 8.75%, 33.75%, or 39.25% depending on whether you are a basic rate, higher rate or additional rate payer.
To improve your tax strategy as a Limited Company director, make wise choices regarding your pension contributions. Investing company money in your pension can save you taxes and help secure your financial future.
For more information on how making pension contributions can save you tax, please read our article.
In conclusion, maximising tax savings through strategic pension contributions presents a valuable opportunity for individuals navigating the complexities of the tax system.
Financial Planning by TaxAssist, along with your TaxAssist Accountant, can analyse your situation. They will find the best ways to lower your taxes and help you save for the future. To speak with Financial Planning by TaxAssist call 0330 441 2244 or email [email protected].
Tax rates correct as of April 2023
* In Scotland income tax rates are 20%, 21%, 42% or 47% so pension contributions save a bit more compared to contributions in England, Wales or Northern Ireland.