The financial decisions we take during our working years will have a huge influence on our quality of life when we reach our senior period. Minimising our tax liability is a very significant factor when it comes to saving for our later years, making the most of our pensions and, ultimately, ensuring that our estate goes to the people we love rather than HMRC.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
Tax treatment varies according to individual circumstances and is subject to change.
The major headline benefit of saving for our later years by means of pensions is that pensions contributions attract tax relief. There are annual and lifetime limits on this relief, however in practical terms they are only likely to have a meaningful effect on particularly high-net-worth individuals. Tax relief is also applied on contributions made by individuals whose earnings are below the income tax threshold. In this case, there is an annual limit of £2,880 in personal contributions, to which 20% tax relief is added, meaning that a person can save a total of £3,600 into their pension each year. People on lower incomes can make higher contributions to their pensions if they wish, it’s just that the tax relief will only be applied on the first £2,880. It’s also worth remembering that some people in this situation may find it beneficial to register for certain benefits (e.g. Child Benefit and Carer’s Allowance), even if the overall household income is too high for them to receive any payments. This is because they can build up NI contributions in their own name and hence improve their own state pension. While the state pension may be less than many people would like to have to live on, if you can claim it, it makes sense to do so, particularly since it may entitle you to other benefits.
Pensioners and taxation
In the old days, taxing pension income was a fairly straightforward matter. You had a fixed income from a state pension and/or a fixed income from an annuity bought with your pension fund. Either or both of these could rise in line with inflation, but essentially your tax bill was much the same from year to year. The “pensions freedoms” introduced in April 2015 mean that pensioners now have the ability to vary their income from one year to another in line with their needs and wants. This, obviously, has implications in terms of tax management and planning ahead, as far as possible can bring very meaningful rewards. For example, if a person thinks there is a reasonable expectation that they will need £5,000 one year and £15,000 the next, it could be best for them to withdraw £10,000 each year, to make the most of their annual, personal allowance.
Estate planning and taxation
While it’s important to leave a will, a will simply indicates who should receive what out of your estate. Making sure that there is something in your estate left for them to receive is the job of inheritance planning. The good news about pensions, or, more specifically, pensions funds, is that they’re excluded from a person’s estate when its IHT value is calculated. The even better news is that as of April 2015 it became possible for pension funds to be passed on from one person to another and as of April 2016, the beneficiary received the income taxed at their marginal rate (as opposed to 45% as before). This has clear implications for estate planning, particularly for those who have younger relatives, such as grandchildren, with no or little income. In such cases it may be most advantageous to bequeath them their share of your pension pot directly so that they can make full use of their personal allowance, rather than having them receive their money via higher-earning relatives who will pay more tax on it to begin with.
The Financial Conduct Authority does not regulate tax and trust advice.