Maximising Your Pension: Tax Planning for Retirement

28th February 2024

When it comes to retirement in the UK, strategic tax planning is imperative for maximising pension savings and ensuring you have a financially secure future.

Whether you’re approaching retirement or just starting your career, every individual should understand the tax relief and strategies surrounding their pensions contributions.

By delving into the key aspects of retirement tax planning, including pension contributions, withdrawals, lifetime allowance, and tax-efficient income strategies, we hope to help people ensure they can plan for the retirement they desire.


Pension Contributions and Tax Relief

Pension contributions are different to other investments as they have a tax relief on pensions contributions, which can help your funds grow faster, significantly boosting your pensions savings for retirement.

This incentive provided by the government is to encourage people to save for their retirement and works through pension providers claiming tax back from HMRC and adding it to individual contributions.

Therefore, taking advantage of this tax relief can be vital to your retirement savings, as more contributions lead to increased government support – so, it is important to understand what’s involved.


How to get tax relief on pension contributions?

When it comes to obtaining tax relief on pension contributions, there are two options:


Relief at source

If you have a personal pension, you will automatically get tax relief through ‘relief at source’.

Your employer will deduct your pension contributions from your pay after tax reductions have been made and then send it to your pension provider. Your provider will then claim the 20% tax relief from HMRC before they place it in your pension pot.

Higher or additional rate taxpayers receive additional relief, which we will discuss in more detail below, and will need to claim this from HMRC.

In addition, self-employed individuals will need to make contributions directly to their pension provider.


Net pay

Alternatively, with the net pay option, contributions are deducted before taxation, reducing your overall tax payments. This relief comes with immediate effect and is provided without the need to claim it back.

Unfortunately, if you don’t have any tax liability, no relief will be granted through net pay, and you will have to use relief at source to benefit from any tax relief to your pension contributions.


How is this tax relief calculated?

Tax relief will be received at the highest rate of income tax you pay, and will vary depending on if you’re a basic, higher, or additional rate taxpayer:


Basic rate taxpayers

If you’re a basic rate taxpayer, you will receive 20% tax relief. This means that every £1 you pay in becomes £1.25, effectively boosting your contribution by 25%.


Higher rate taxpayers

However, if you’re a higher rate taxpayer, you will receive 40% tax relief. This means that every £1 you pay in becomes approximately £1.66, boosting your contribution by 66%.


Additional rate taxpayers

Finally, if you’re an additional rate taxpayer, you will receive 45% tax relief. This effectively boosts your contribution by 80%.


If you’re a higher or additional rate taxpayer, to receive the additional tax relief on your pension contributions, you will need to claim any relief extra to the basic 20% tax relief back from HMRC.

Alternatively, if you’re unemployed or earning under £3,600 annually, you can still contribute to a pension and take advantage of this tax relief. However, your tax relief is limited to contributions up to £2,880 per year. Although additional contributions to your pension savings are allowed, they won’t qualify for tax relief.


Does this tax relief help to reduce income tax?

Pension contributions are exempt from income tax, however, contributing from earnings doesn’t directly lower your taxable income. However, you could benefit from a salary sacrifice scheme. Effectively, this will reduce your taxable income, as employers will make extra pension contributions in exchange for a salary decrease.


What is the contribution allowance?

You can receive tax relief on up to 100% of annual earnings (up to the £60,000 annual contributions allowance), although this is subject to individual limits, excluding employer contributions.

However, exceeding these limits may lead to additional charges. Therefore, seeking advice from a professional can help ensure you are aware of the latest regulations and contribution limits, helping to avoid incurring any further tax charges.


Pension Withdrawals

Most personal pensions have a minimum withdrawal age of 55, although your pension provider determines when you can start taking money out of your pension. However, pension withdrawals can have tax implications.

When you make a withdrawal, your pension provider will deduct any applicable taxes before releasing your funds. If you make a large withdrawal, you may incur a higher tax rate, and additional taxes could apply at the end of the tax year.

There are several strategies for withdrawing your pension:


Lump sum withdrawals

You can withdraw up to 25% of your pension as a tax-free lump sum, which is capped at 25% of your lifetime allowance (which is currently £1,073,100).


When you have taken your tax-free lump sum, you have a 6-month window to withdraw the remaining 75%, although this will typically be subject to taxation. This can be done by either buying an annuity, or selecting ‘flexi-access drawdown’, or a direct cash withdrawal. Again, this can depend on your pension provider.

Having lifetime allowance protection may increase the tax-free lump sum available.


Annuity purchase

An additional option is purchasing an annuity from an insurance company, ensuring regular payments for life. The payment amount is influenced by factors such as age, gender, pension pot size, interest rates, and health.


Drawdown funds

There are two types of drawdown funds to manage your pension, such as a flexi-access drawdown fund, which provides diverse options such as withdrawals, short-term annuities, and contributions (taxed over the money purchase annual allowance).

Alternatively, if you possess a ‘capped drawdown’ fund, your money remains invested, allowing withdrawals within predetermined limits. These limits undergo regular reviews until you reach the age of 75 and are reviewed annually thereafter.


Direct cash withdrawal

You may be able to withdraw cash directly from your pension pot, either the entire sum or smaller amounts. However, contributions may be allowed but are subject to taxation over the money purchase annual allowance.

You cannot take smaller cash sums if you’ve reached your lifetime allowance, have certain types of lifetime allowance protection, or if you’re under 75 and the desired withdrawal exceeds the remaining lifetime allowance.


Lifetime Allowance

The current lifetime allowance for tax relief is £1,073,100. However, the tax rates for pensions savings above the lifetime allowance depend on the method of payment used and when your pension started.


Tax rates before 6 April 2023

If you took your pension out before 6 April 2023, the tax rate for withdrawing as a lump-sum is 55%. However, if you withdraw by other methods (e.g. pension payments or cash withdrawals), the tax rate for withdrawing is 25%.


Tax rates after 6 April 2023

If you took your pension out after the 6 April 2023, there is no lifetime allowance charge.

The lifetime allowance for pension pots was removed for the current tax year and will be scrapped from April 2024. Instead, Income Tax applies on some or all the lump sum and will be deducted by the pension provider.


Maximising Tax-Efficient Retirement Income with Edwards Accountants

Building a tax-efficient retirement income is the foundation of a financially successful retirement plan. At Edwards Accountants, our experienced accountants can help you navigate the complexities of retirement tax planning and personal tax planning.

We work closely with you to offer practical tips and strategies for maximising tax efficiency in retirement, minimising tax burdens and helping you make the most out of your hard-earned savings.