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Saturday, 9 October 2010

Tax advantages of personal pensions

Pensions are long-term investments designed to help ensure that you have enough income in retirement. The government encourages you to save towards your pension by offering 'tax relief' on your contributions.

How tax relief on personal pensions works

For each pound you contribute to your scheme, the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot.

If you pay a higher tax rate

If you pay tax at 40 per cent

If you're on the higher tax rate of 40 per cent, you can get 40 per cent tax relief on your contributions. This relief is only available up to the amount of your income that is taxable at 40 per cent.

The way that the money is given back to you is different. The first 20 per cent is claimed back from HM Revenue and Customs (HMRC) by your pension scheme. This is the same way as for a basic rate taxpayer.

It's then up to you to claim back the other 20 per cent. You can do this when you fill in your annual tax return or by contacting your Tax Office by phone or letter. They will need to see details of the payments made.

If you pay tax at 50 per cent

If you’re on the additional tax rate of 50 per cent as well, you can get 50 per cent tax relief on your contributions.  This relief is only available up to the amount of your income that is taxable at 50 per cent.

The way the money is given back to you is different. The first 20 per cent is claimed back from HMRC by your pension scheme in the same way as for a basic rate taxpayer.

It’s then up to you to claim back the other 30 per cent when you fill in your annual tax return.

Can non-taxpayers get tax relief?

If you don't pay tax, the most you can pay in with tax relief is £2,880 a year. But you'll still get basic rate (20 per cent) tax relief. In other words the government will 'top up' your contribution to make it £3,600.

Limits on pension tax relief

You can save as much as you like into any number of pensions. You get tax relief on contributions of up to 100 per cent of your earnings each year, provided both the  following apply:

  • you paid the contribution before age 75 
  • you did not make contributions above the 'annual allowance'

For the tax year 2010-2011 the tax allowance is £255,000 and for the tax year 2009-2010 it was £245,000. Savings above the annual allowance and a separate 'lifetime allowance' will be subject to tax charges.

Under changes announced in the 2009 Budget, from April 2011 the amount of tax relief will reduce if your income is £150,000 or more. Restrictions were introduced from 22 April 2009 to stop people making large additional pension contributions and getting full tax relief ahead of April 2011. The restrictions will apply to you if all of the following apply:

  • your total pension savings are more than £20,000 (or more than £30,000 in certain circumstances) 
  • you change the amount of your normal regular pension savings 
  • your income is £150,000 or more (from 8 December 2009 this reduced to £130,000 or more under changes announced in the 2009 Pre-Budget Report)

Other tax advantages

There are more tax advantages to being in a pension scheme:

Pension fund growth

The money you save (including the tax relief amount) in your pension will be invested by your pension scheme. Your pension fund growth may be free of tax.

Capital gains tax

Any rise in the value of the scheme's assets between what you put in and what they're worth at the end is called capital gains. This is tax-free.

Withdrawing funds as a retirement lump sum

You may be able to withdraw up to a quarter of the value of your stakeholder or personal pension fund as a tax-free lump sum. Your pension provider will be able to tell you whether or not you will be able to do this.

If you want to put money into someone else's personal pension

You can put money into someone else's personal pension – like your husband, wife, civil partner, child or grandchild's. They'll get tax relief added to it at the basic rate, but this won't affect your own tax bill. If they've got no income, you can pay in up to £2,880 a year (which becomes £3,600 with tax relief).

For example, if you put £80 into a spouse or civil partner's pension scheme, the government would put in £20, so their pension pot would increase to £100. Your tax would remain the same. These rules might be changed in 2012. Read ‘Passing money to your children and grandchildren’ to find out more.

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