Pensions / Tax

How can I be tax efficient with my UK pensions?

Choosing how you are going to fund your living costs in retirement is one of the most important steps when considering your finances. Peter Webb, our Head of Tax Advisory, takes a look at the tax benefits available through pension schemes.

A UK pension scheme could be one of most powerful tools when planning your retirement. Pensions come with significant advantages that make your retirement savings work harder. Notably any investments held within your pension fund grow free of Income Tax and Capital Gains Tax and are also protected from Inheritance Tax too. Pensions are essentially a long-term savings plan with tax relief.

You generally contribute to your pension over your working life when you are paying tax at the highest rates. Making contributions to your UK pension scheme means that some of the money that would have gone to the government in tax goes into your pension instead. In addition, the government make contributions too. So, while you’re working, you’ll be able to reduce the amount of tax you pay and get free money from the government.

Even if you’re not working you may still be able to make the minimum pension contribution of £2,880 which the government will top up to £3,600 for you. As always there’s a catch; sadly, it’s not all good news! There are limits to the amount that you can contribute to your pension scheme each year and an overall limit to the amount of pension savings you are able to accumulate over your lifetime. As well as this, there are restrictions on when you can start receiving income from your pension. And don’t forget that the income you receive will then be taxed. The current age restriction for receiving income from your pension is 55, but that will rise to 57 from 2028.

Why save into a pension?

Pensions allow you to reduce your tax bill when you are earning well and paying tax at the highest rates, grow free of Income and Capital Gains Tax, protect you from Inheritance Tax, and allow you to take a taxable income in retirement when you are likely to be paying tax at lower rates.

Making pension funds tax efficient

There are some key steps to work through to help make sure your pension stays tax efficient:

  • Understand the limits for saving into your pension fund each year; it’s likely to be a maximum of £40,000 and a minimum of £4,000.
  • The current lifetime limit for pension savings is £1,073,100. If that limit is exceeded there are penalties to pay so consider whether or not you are eligible to apply for “fixed protection” which will allow you an increased lifetime allowance of, perhaps, £1,250,000 or the value of your pension savings at 5 April 2016.
  • When you reach retirement age, you’re generally able to take a cash free lump sum of up to 25% of your pension fund. At this point you have choices; you don’t have to take the whole 25% and can withdraw as much or as little as you need. So, ask yourself whether it would be better to leave more of the fund invested allowing it to grow free from tax and protected from Inheritance Tax.
  • You can generally draw down any amount from a pension fund once you reach pension age but receiving a significant sum might push you into paying higher rates of tax in that year. If the payment was spread out over a number of years you might pay less tax on the amounts taken.
  • Remember that your pension fund is protected from Inheritance Tax and you may be able to pass it on to, for example, your wife or children free of this charge. So, you may want to consider exhausting other sources of investments before taking money from your pension.
  • Don’t forget to consider the investments within your pension scheme. Are they working as hard as they can for you? Just like your other investments you have choices as to what your pension fund is invested in so make sure your pension funds are reviewed by an independent financial planner as well.

To discuss any aspect of your retirement plan, including your pension, please contact your nearest office.