How do I top up my pension?

You can maximise your private pension in the years before you retire by making extra contributions to it. You can do this at any time, but it may be more practical to do so near retirement.

Topping up your pension in your final working years can result in a higher income when you retire. Here’s an explanation of how it works and a summary of the pros and cons.

How pensions work (quick recap)

Most workplace pensions (and all personal pensions) involve you paying into an investment fund over many years. This steadily growing portfolio of investments is known as a pension pot. You can access your pension pot in a number of ways from the age of 55.

Money paid into your pension qualifies for tax relief, which has the effect of boosting it by 25 per cent (or more if you pay higher rate tax). Growth is also free of tax. This makes your pension a very powerful way to maximise your retirement savings.

Find out more about how pensions work.

What are the benefits of making large pension contributions?

Normally you’ll pay a regular sum into your pension each month. However, there are several reasons why you might want to make large one-off contributions.

Increase your pension pot

This is the simplest reason: it’s good to store away as much money as you can in your pension, to generate as much growth as possible before you need to start drawing an income from it.

Boost your savings with tax relief

Every payment you make into your pension benefits from 20 per cent tax relief (more if you’re a higher-rate taxpayer). This means that every pound in your pension only costs you 80 pence in contributions. There’s no better way to give your savings such an instant boost.

Shelter money from inheritance tax

Pension pots are exempt from inheritance tax (IHT), and you can pass them on tax-free when you die. This means that if your estate may be subject to IHT, you can reduce it by making additional payments into your pension, and still pass on the money in the event of your death.

Use up your annual allowance

Everyone has an annual allowance which the maximum payable into pensions in any given tax year (currently £40,000). Any unused allowance from the previous three tax years can be ‘rolled over’ to the current year. So if you paid £20,000 a year into pensions for the past three years, then this year you could contribute a total of £100,000 (this year’s £40,000 plus £60,000 carried over).

Avoid the child benefit tax charge

Child benefit is worth £2,501 to a family with three children. However, you’ll pay a tax charge if either parent earns £50,000 or more, and this charge completely cancels out the benefit if either parent earns £60,000 or more. However, you can reduce your taxable income by paying into your pension. If this reduces your income below £50,000 then you can still receive the child benefit. You’ll also receive higher-rate tax relief (40 per cent) on the contribution, making this strategy even better value.

Maximise your bonus

If you receive bonuses from your employer, you may be able to obtain more value by requesting an employer pension contribution instead. A pension contribution saves on both employer and employer National Insurance contributions, meaning you could receive more money that you would have as a cash bonus. This would also reduce your overall taxable income for the year, potentially enabling you to avoid the child benefit tax charge (see above).

When is a good time to pay more into my pension?

You can make additional payments into your pension at any time. Just remember that you can’t access your pension until you’re 55 (at the earliest), so don’t pay in any savings that you may need before then.

Once you reach 55, you can transfer savings into your pension knowing that you can access them again if you need to. Be aware however that a pension is not like a bank account, and that there can be drawbacks to accessing your pension too early – see below. A financial adviser can help you decide what to do.

What are the drawbacks of transferring savings into my pension?

Despite the boost to your savings if you move them into your pension, there are some disadvantages of doing this. Make sure you consider these before making any decisions.

1. Pension withdrawals can be taxed

When you draw money from your pension, it counts as income and so can be taxed. You’ll still have your tax-free personal allowance, but any income above this will be taxed at the normal rate. If you draw too much in one year, you may largely cancel out the boost you received from tax relief.

2. Pensions can fluctuate in value

Pensions are invested in assets designed to deliver long-term growth. This means that in the short term they can fluctuate a great deal. Bear this in mind if you want to access a large sum in the near future (e.g. to buy an annuity) – in which case you may want to move your pension fund into lower-risk assets.

 3. Accessing your pension limits how much you can pay in

Although you can access your pension at any time from the age of 55, doing so reduces the amount you can pay into it. Once you start to access your pension, your annual allowance reduces to just £4,000 (from £40,000). Therefore, avoid transferring money you might need in the short term into your pension, if you also plan to continue contributing to your pension.

4. You might exceed your lifetime allowance

If you have a lot of pension savings, a large contribution might take you over the lifetime allowance. This isn’t a danger for most savers, but is something for high earners to bear in mind.

Should I top up my pension?

If you have savings or income to spare and are approaching retirement age, additional contributions may be a good idea for you. However, you should talk to a financial adviser first to ensure you are making the best decision.

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