Pensions & tax efficiency — how to set up for a tax-free retirement

Jun 27, 2023 | Business tax, Self-employed

Pensions can be an incredibly tax-efficient way to save money for the future. But many individuals and businesses in the UK neglect pensions as a necessity rather than a real benefit.

If done right, a pension can be a light at the end of the tunnel, a fitting end to an illustrious career, and something that sets you up for a beautiful retirement.

This article will help you understand how to be more tax efficient with your pension scheme and create a plan that will work for your staff.


How do I get tax relief on a pension?

Income tax relief allows you to exclude some of your income from assessment for income tax in exchange for a pension contribution.

For example, if you earn £50,000 and contribute £10,000 of it to a pension, you’re only taxed as if you were earning £40,000.

This saves £2,000 income tax (20% of £10,000) at current tax rates.

You need to make qualifying contributions to get this relief on your pension. It’s essentially a reward from the Government for saving for the future – and not relying only on a state pension. These contributions are tax-free as long as they’re under the annual allowance.


Annual allowance

The current annual allowance (the total amount you can contribute to a pension each year without getting taxed) is £60,000.

Your annual allowance may be reduced if your adjusted income exceeds £260,000 and your threshold income exceeds £200,000, or if you have accessed your pension using one of the flexible access options introduced in April 2015.

You can contribute 100% of your relevant earnings and provided your total contributions from all sources don’t exceed your annual allowance, you will receive income tax relief on your personal contributions.

Of course, there are other ways to save for retirement. For true tax efficiency, they should all be considered as part of a ‘retirement plan’.


Four sources of retirement income and their limits

To be tax efficient in retirement, you must stay within the boundaries and limits of each savings vehicle you use. On paper, it’s simple — in practice, it can be more convoluted.

Here are the four main sources of income and their limits:

  • Pensions. After the age of 55, you can usually withdraw up to 25% of your pension as a tax-free lump sum (capped at £268,275), with ensuing withdrawals taxed at your marginal income tax rate.
  • Individual savings accounts (ISAs). You can withdraw as much money as you like from ISAs without paying tax.
  • Savings accounts. Basic-rate taxpayers can earn up to £1,000 of tax-free interest on savings each year; this reduces to £500 for higher-rate taxpayers and £0 for additional-rate taxpayers.
  • General investment accounts. The capital gains tax (CGT) exemption lets you realise up to £6,000 of tax-free gains in the 2023/24 tax year.

Balance these four sources out, and you’ll have yourself a healthy, tax-efficient and effective retirement strategy.


Make your pension work for you

Like every investment opportunity, there are positives and negatives to using a pension scheme.

And what with the occasional threat of a complete market collapse, putting your faith in a pension provider might feel like a daunting option.

In times of uncertainty, consult an expert. That’s us. We’ll discuss your assets, options and tax obligations to find the best solution for you and your business.

Looking for an accountant to help you make your pension tax efficient? Get in contact and set up a meeting with us.

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