Maximising Your Retirement: A Guide to Pension Contributions and Tax Benefits

Navigating the world of pensions and retirement planning can be complex, but it's a crucial part of securing your financial future.

Many of our clients ask us about the benefits of making regular pension contributions especially with saving rates being at their highest level for many years.

For example, is it a good idea to pay into a Cash ISA offering a guaranteed return of 4% over a pension holding investment funds?

While funds can be volatile and may indeed see a loss over the time period of the ISA interest rate offered, a secure 4% return is tempting to many (although it is worth noting of course that pensions can also be invested into cash deposits).

And whilst a comprehensive financial plan will usually involve a range of savings, investments and other assets, pensions have some key benefits that are worth examining.

Let’s look at examples for both a work-based scheme and your own private pension below, to give you an idea of how your contributions could enhance your pension.

*Note that all examples relate to taxpayers in England, Wales or Northern Ireland and refer to defined contribution scheme investment, and figures and information are correct at time of publication.

Private pension contributions and tax relief

One key advantage is that if you make a personal pension contribution within your personal allowance, you’ll receive immediate tax relief at your marginal rate.

An example of this would be:

For an individual not earning an income, you’ll receive a 20% tax relief payment into your pension based on the first £2,880 you pay in.

This means you’ll make a gross investment of £3,600.

If you are a basic rate taxpayer, then you’ll receive a tax relief payment of £20 for every £80 you pay in. This would be the equivalent of investing £100 for every £80 from your bank account!

An added bonus of this is that claiming the tax relief is normally done for you by your pension provider.

If you pay Income Tax above 20%, you can claim even more tax relief using your self-assessment tax return. Here, an individual would be able to claim:

20% up to the amount of any income you have paid 40% tax on
25% up to the amount of any income you have paid 45% tax on

You can complete a self-assessment via the HMRC self-assessment website, through an accountant or by writing to HMRC to claim if you pay income tax at 40%.

Let’s look at the following example of how this would affect contributions:

Let’s imagine that ‘Individual A’ earns £60,000 in the 24/25 tax year and pays 40% tax on £9,730 (where the annual allowance for a basic rate taxpayer is £50,270, so the £9,730 is the excess and therefore subject to the 40% tax).

They could then put £15,000 into a private pension to automatically get tax relief at source on the full £15,000.

‘Individual A’ could then also claim an extra 20% tax relief on the £9,730 (the same amount they paid higher rate tax on) through their Self-Assessment tax return.

They would not however, get additional relief on the remaining £5,270 they put into their pension.

Overall, this means ‘Individual A’ would have made a total investment of £18,750 at a net cost of £13,054!

The tax relief on contributions (amongst others!) means that pensions can be a great way to invest for your future.

Work-based scheme pension contributions

Let’s now consider contributions into a workplace pension scheme. There are many different workplace pension providers including Nest, Royal London and Aviva.

Auto-enrolment legislation introduced in 2012 means that workers need to manually opt out of their work pension scheme. Since introduction of this legislation, more UK employees than ever are paying into their workplace pension scheme.

A workplace pension will certainly help with later life living, especially when the future of the state pension is subject to review.

We have already seen the state pension age rise for both men and women, and this is due to rise again between 2026-2028 and further still between 2044-2046.

It is also anticipated that retiring early (or at least comfortably!) is unlikely to be sustainable without a good level of personal pension wealth.

The long-term thought is that the state pension will never be a means tested benefit but with the age rising to 68 by 2024, it is showing signs that sustainability is going to be difficult with the growing age of the population.

When looking at your pension planning, a good place to start is with your workplace scheme. Not only do you receive the tax relief on your own contributions, but your employer will also be paying into the scheme.

For someone ready to start their pension journey this is a great way to boost your retirement, as many employers match your contributions up to certain levels.

It is true that your future pension income will be taxed at the marginal rate when you retire, and for many individuals this will likely be at the basic rate.

But don’t forget that under current rules you are also able to take 25% of your pension tax free.

This does still mean that a good portion of your pension will be taxable, but if you are able to save over many years, the tax relief you have received will also form part of your potential growth.

Should someone start saving for their pension at their first opportunity, their savings are likely to see over 50 years of investment. And, whilst growth can never be guaranteed, this should, with careful advice, see a secure retirement.

It may seem early, but a worthwhile exercise is to calculate what sort of income you need in retirement.

How much will you need to save for retirement?

Begin by assessing your total outgoing and allow for things like holidays, emergencies and your desired lifestyle, as this can help with seeing how much your private pension will need to be.

The full state pension is currently £11,502 a year (the full basic state pension is £8,814 per annum), so additional retirement income from a private pension will likely be needed

A married couple earning the full state pension with no other income sources would generate almost £2,000 per month.

So, saving just £100 per month with even just annual growth of 2% for 50 years would be worth over £100,000 over the long-term, and having a pension fund paying an annuity (an income for life based on the size of your pension pot) or flexibly would mean a more secure retirement.

Potential Pension changes in the 2024 Autumn Budget

At the time of writing, there is a potential for tax relief to change on the pension contributions in the 2024 Autumn budget. Currently, a significant portion of tax relief (estimated at 56%) is at the higher rate.

Reducing the relief to a flat 20% would represent a considerable tax saving for the government but would be extremely unpopular amongst savers.

It is possible that reduction from the 40% may be announced, so it may be worthwhile considering a lump sum payment before any new legislation is brought in.

As discussed, when it comes to your retirement, having a range of investments, savings, property and additional assets is desirable, but it is also clear that contributing into a pension in any capacity should form an important part of your financial planning.

If you’re ready to take the next step, why not schedule a consultation with our financial experts to discuss your unique retirement goals and explore the best pension options for you.