Due to the complexity of our tax system, there are some occasions where making a pension contribution can benefit you beyond the initial tax relief.
We all know that pensions offer great tax incentives – but did you know there are some hidden ways they can help boost your finances?
The dizzying array of taxes and thresholds may be difficult to understand but they can offer secondary benefits.
Here we outline four ways that paying into your pension can help shield your money from the taxman and set yourself up for a comfortable retirement.
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1. Reducing your salary below £50k for a bigger PSA
The idea here is to double your personal savings allowance by taking your salary down to the point where you’re no longer a Higher Rate taxpayer.
The Personal Savings Allowance (PSA) has remained the same since 2016, with Basic Rate taxpayers entitled to £1,000 tax-free cash interest on savings outside of a tax wrapper.
But for those paying the higher 40% Income Tax rate, the allowance halves to just £500 while Additional Rate taxpayers paying the 45% Income Tax rate receive no concession at all.
Alice Haine, personal finance analyst at Bestinvest, believes it can make sense to top up your pension by taking advantage of ‘salary sacrifice’ if your employer agrees to it
“This is where a member of staff agrees to reduce their salary or forgo a bonus payment and instead receive an increased pension contribution to drop a tax band,” she said.
The deduction reduces the worker’s salary, meaning they pay less Income Tax and National Insurance.
Those earning just above the £50,270 earnings threshold – where the higher 40% tax rate kicks in – could dip under it by using this approach.
“They would not only pay less tax on their income but also give their pension savings a healthy boost and also double their Personal Savings Allowance to £1,000,” she added.
2. Cutting your salary to £60k to avoid the Child Benefit Charge
The idea of reducing your salary to £60,000 is so that you can avoid the High Income Child Benefit Charge.
This kicks in if one parent earns over £60,000 and effectively removes 1% of Child Benefit for every £200 you make over £60,000, according to Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.
It has to be repaid through Self Assessment – and if you earn over £80,000 then it removes your entitlement entirely.
“Current rates put someone with two children as able to claim £2,212 per year in Child Benefit so it can form an important part of household budgets,” she added.
Once again, Alice Haine at Bestinvest believes those on decent wages could explore how salary sacrifice can cost-effectively reduce their income.
“A higher earning parent could potentially ensure they receive their full child benefit entitlement of £25.60 a week for their first child and £16.95 per child for additional children,” she said.
3. Avoid the 60% tax trap
For those on larger incomes, reducing your salary to below £100,000 will avoid the 60% tax trap… and boost your pension at the same time.
This tax rate may not exist officially but that’s the reality for anyone earning between £100,000 and £125,140, according to Bestinvest’s Alice Haine.
“Under this tax system quirk, for every £2 of taxable income above £100,000, they lose £1 of the personal allowance of £12,570 until it disappears entirely,” she explained.
Haine suggests that workers who fear a pay rise or bonus will tip their income over £100,000 should also check if their employer offers ‘salary sacrifice’ as an option.
“Some employers will let their staff reduce their salary or bonus payments instead of increased pension contributions, which means the staff member gets the double bonus of boosting their pension while also reducing their tax liability at the same time,” she said.
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4. Take advantage of existing tax breaks
Taking advantage of existing pension tax relief rules, as well as the current annual allowance while you can, is crucial for longer-term savers.
Alice Haine pointed out there were rumours that Chancellor Rachel Reeves may tinker with pension tax relief, meaning Higher and Additional Rate savers, might not enjoy the same tax breaks.
“Speculation she may introduce a flat rate of tax relief, such as 30%, would see higher and additional rate taxpayers lose out as they can currently claim an additional 20% and 25% respectively, on top of Basic Rate relief,” she explained.
The annual allowance, currently capped at £60,000 or 100% of your earnings, whichever is less, may also come under scrutiny so pension savers should take advantage while they still can.
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