To address this and encourage people to save more, HMRC will give back 100% of the tax on pension contributions up to your earned income/annual allowance.
The best way to understand how this works is with a quick example.
Let’s say you get an £8K bonus at work and decide to put the lot into your personal pension. We then claim the basic rate of tax relief for you - £2K - and add it to your £8K, making £10K.
If you’re a higher rate taxpayer you get back another £2K via your tax return, leaving you £6K out of pocket at the end of the year but with £10K added to your pension.
It’s slightly different for company pensions. Your contribution is usually taken out of your salary before it’s taxed, so there’s no tax to pay.
Basic rate taxpayers could save 20% or £2K on a pension contribution of £10K, higher rate taxpayers save 40% or £4K, and additional rate taxpayers could save 45% or £4.5K.
You can get your hands on your money when you’re 55 or a little older (depending on your age now). The first 25% is tax free (often called the tax free lump sum), with the remainder taxed as income. This gives you real control over how much tax you pay as you can keep your withdrawals just below your tax threshold - great news for everyone except HMRC.
The key thing to know is that putting money into your pension is a really tax-efficient way to invest an earned lump sum. There’s plenty more to consider (this is the knotty world of tax and pensions after all), but that’s the gist. To find out what all this could mean for you, try the calculator above or get in touch. That’s what we’re here for.
* We’ve tried to keep things simple here, however if you’re lucky enough to earn over £100k then you should be aware of two things. Firstly, the loss of personal allowance at the rate of £1 for every £2 earnings over £100k such that your £12.5k allowance is all gone by £125k. Secondly, pension tapering. From the beginning of the tax year 2016/17, for every £2 your adjusted income goes above £150K, your annual allowance for that year will drop by £1 - hence the name “tapering”. The drop is limited so that your minimum tapered annual allowance is £10K. The easiest way to work out your own tapered annual allowance is to follow HMRC’s guidance here.