Your workplace pension is an amazing long-term savings vehicle. But are you making use of its full potential? Steven Mason, chartered financial planner at Gilliland Neilson Brown, gets you up to speed.
If you have a workplace pension you can already feel pretty smug – because as a long-term investment it’s quite tough to beat. Firstly, you typically get an automatic 20 per cent tax relief on your contributions. This means that every 80 pence you pay in instantly becomes £1. Secondly, your employer will contribute too, often doubling or even trebling the amount going in. Employer contributions are tax-free too. This means that your money gets a huge boost even before all the lovely compound interest kicks in.
On top of all this good news, there may be even more benefits that some pension savers can take advantage of. So let’s take a look under the bonnet of your workplace pension to make sure you aren’t one of those missing out.
Top tip 1: How to boost your pension contributions
Changing the way you make your pension contributions could boost these by as much as 12 per cent, and sometimes by up to 25.8 per cent, without costing you an extra penny. This can result in a much larger pension when you retire, at no additional cost to you. So how does that work?
The key is how you pay into your pension. Normally, you would pay into your pension out of your salary (net of tax), with the payment made automatically via PAYE. Though these pension payments receive tax relief, you still pay National Insurance (NI) at a rate of 12 per cent.
But some employers let you make pension contributions a different way, via a salary sacrifice scheme. This means your gross salary is lowered, in exchange for the pension contribution. Because this money is no longer salary, you don’t pay the NI and so you save 12 per cent. You can either rebate this into your pension to boost the level of contribution and maintain the same take-home pay, or you can maintain the level of pension contribution and instead boost your take-home pay.
The good news goes on. Your employer also pays NI on your wages (at 13.8 per cent), and may choose to rebate some or even all of this money to you (as it’s cost neutral for them to rebate it all, or they can benefit by doing a partial rebate). So in that event, basic rate tax payers would receive a 25.8 per cent uplift on personal pension contributions at no additional cost to take-home pay. And that’s in addition to the 20 per cent tax relief.
If you’re a higher-rate taxpayer, the saving isn’t as much (you’ll only save 2 per cent in NI contributions). However it’s still worth looking into, especially if the employer will rebate their NI payments to you. As always, there are caveats – salary sacrifice can affect the state benefits you may be entitled to, or the amount you can borrow on a mortgage. Talk to a financial adviser before making any decisions.
Speaking of higher-rate taxpayers brings us to tip number two.
Top tip 2: Claim your higher-rate tax relief
If your earnings mean you pay income tax at a higher rate, you may be be aware that you’re entitled to higher-rate tax relief on your pension contributions. What you may not be aware of is that this relief doesn’t necessarily happen automatically. Most pension schemes will only handle basic-rate (20 per cent) tax relief automatically. For higher (40 per cent) and additional (45 per cent) rate tax relief, you’ll need to make claims via your self-assessment tax return.
The important thing to note is that you only have a limited time frame within which you can make these tax reclaims, after which the extra tax relief is lost. You’ll need to claim within three years of the end of the tax year for which you’re claiming. So including the current year, you could potentially claim back up to four years of tax relief you might have missed out on. In some cases this could be many thousands of pounds.
If you happen to be earning above £100,000 from all sources, including salary, car allowance, interest, dividends etc. then you will lose your tax free personal allowance (currently £11,850 in the 2018/19 tax year). This means that on the band of earnings between £100,000 and £123,700 you'll be paying an effective tax rate of 60 per cent! But by making pension contributions, or increasing them, you can potentially recover the full tax free allowance.
The quickest way to find out whether you’ve missed any tax relief, or any other trick for boosting your pension, is to contact a financial adviser for a pension review.
N.B. The above information is based on tax rates in England and Wales. The uplift in Scotland is even higher than that stated above.