Here's how millions of Brits can reclaim tax that they've never even paid!
One of the best things you can do when you start work is to start a pension at the same time.
If it seems odd that you should begin saving for life after work from the day you start work, then that's the harsh reality of retirement in the 21st Century.
After all, baby boys born today can expect to live an average of more than 77 years and baby girls nearly 82 years. Hence, in order to pay for, say, 20+ years of retirement, you need to start a pension early and save hard throughout your career.
The taxman chips in
The good news is that you get outside help when you contribute to your pension.
In many cases, your employer will match or beat your contributions. For example, it may ask you to pay in 5% of salary and, in return, will contribute another 10%, for a total contribution 15%.
What's more, HM Revenue & Customs (HMRC), alias the taxman, is also keen to part-fund your retirement.
If you're a basic-rate (20%) taxpayer, then you get 20% tax relief on pension contributions. In other words, putting 5% of your before-tax pay into a pension will cost you only 4% of your after-tax pay, with the other 1% coming from HMRC.
For higher-rate (40%) taxpayers, a 5% contribution costs just 3.6% of pay. For additional-rate (50%) taxpayers, putting 5% into a pension costs just 2.5% of tax-home pay.
How much you pay into a pension is up to you, but I would suggest taking maximum advantage of any employer contributions, plus the tax relief on your own pension payments. Saving, say, a total of 15% of your earnings throughout your working life should lead to a decent pot to retire on. With any luck, this may cost you less than 5% of your take-home pay.
Non-workers can have a pension
However, you don't need a job in order to contribute to a pension.
In fact, you don't even need to be an adult to pay into your a personal pension. The truth is that all UK residents under 75 years of age can start a pension, regardless of their age and work status. This includes the self-employed, unemployed, people with disabilities, plus children of all ages.
For these non-taxpayers, there is an upper limit on how much they can pay into a pension and get tax relief. This ceiling is £3,600 per tax year, which can be paid a lump sum, monthly contributions, or occasional payments.
These pension payments attract tax relief, but only at the 20% rate. Even so, this means that the maximum personal contribution is £2,880 a year, plus £720 of tax relief, making £3,600 in total.
What's remarkably generous about this system is that the person paying into the pension gets 20% tax relief on these contributions, even though s/he may have never paid a penny in tax.
Free money from the taxman
Let me give you a practical example, based on the pensions I set up for my son and daughter.
For several years, I paid the maximum £3,600 into low-cost pensions for my little boy and girl. However, thanks to £1,440 of tax relief, this £7,200 a year cost me just £5,760. Therefore, my children have received £1,440 a year in tax relief towards their pensions, despite having never paid any tax whatsoever.
For the sake of argument, let's say that I paid in the same amount each year for the first 18 years of their lives. At age 18, I would have paid a total of £64,800 into each pension (18 times £3,600) at a cost after tax relief of £51,840, thus gaining £12,960 from tax relief.
In other words, across both pensions, my children would have received nearly £26,000 in tax relief, despite never having earned enough to pay any tax. Now that's what I call a free lunch!
Why bother?
No doubt some readers would argue that claiming tax relief when you've never paid tax is 'gaming the system'. In some ways, they'd be right, but this option remains open to well-off families and non-workers -- until the government gets rid of it, at least.
What's more, paying into a child's pension from a very early age gives him/her the benefit of perhaps 65 years of investment growth. After 65 years growing at, say, 7% a year, every pound grows to be worth over £81, which is a huge uplift.
Of course, this calculation doesn't take account of inflation (the rising cost of living), which will dramatically reduce the buying power of this £81 in 2076. Nevertheless, pensions for children demonstrate the incredible power of compounding investment returns over a lifetime.
Learning important lessons
I hope that funding pensions for my children will turn out to be the best financial support I ever give them.
With any luck, my children will never have to pay into a pension themselves, as I'll have done all the hard work for them. However, they won't be able to dip into their pensions until they reach 55, which is at least 45 years away. So I’m not expecting a thank you card, as I'm almost sure to be dead and gone before they claim their pensions!
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