Updated 13 March 2017
More and more people are finding an ingenious way to beat the taxman – and the government’s doing nothing to stop them. In fact, they’re actively encouraging it. Welcome to one of the world’s safest and most profitable tax havens: your pension.
Every so often we hear about another celebrity or public figure who’s been caught fiddling their taxes, usually with some absurdly convoluted scheme involving a Swiss bank account, a Bermudian holding company and a biscuit factory in Belize. However, they’re all wasting their time. When it comes to paying less tax, it’s hard to do much better than the humble pension.
‘Pension’ may not seem a very exciting word, with its associations of getting older and counting the pennies. Perhaps a better description might be: High-Growth Long-Term Investment Fund with Unparalleled Tax Relief. Because there really is no other investment that comes with the same level of tax protection.
Some people think ISAs are similar to pensions – they’re not. You’ll pay no tax on the interest from an ISA, but you won’t get tax relief on the income you pay in. Whereas, when you pay into a pension, you effectively receive additional free money from the government at your marginal rate of tax. So if you pay income tax at 20 per cent, then you can pay just £8,000 into a pension and it will become £10,000. And if you pay tax at 45 per cent, then to get that same £10,000 you only have to pay in £5,500. Can you think of another account that offers 45 per cent growth instantly? Neither can we.
Tax relief in action
Currently the government gives back roughly £35 billion a year to pension investors. What’s more, this tax relief is threefold. Firstly there is tax relief on the initial investment, as described above. Secondly, any growth on the fund is free of income and capital gains tax (as in an ISA, although a pension fund’s growth should far exceed any ISA). Finally, there is tax relief at the end, as you can usually take 25 per cent of the final pot as a tax-free lump sum (with any further withdrawals subject to income tax). Also remember that you can keep paying into this amazing fund until you are 75.
Here are some more examples of how pensions essentially generate ‘free money’.
Generally speaking, you can contribute an amount equal to your earnings each year and receive tax relief on it, although of course most people will not usually be in a position to do that. However, suppose that Esme’s grandmother dies and leaves her a substantial sum of money. Esme earns £35,000 a year, so she can contribute that amount gross. To do this, she needs only to contribute £28,000. Basic rate tax relief of £7,000 then makes up the total of £35,000.
The maximum amount you can pay in each year (and still receive tax relief) is £40,000 – the annual allowance. However, any unused annual allowance can be carried forward up to three years. This means that some top earners could pay in up to £190,000 and receive up to £85,500 in tax relief. That’s a lot of free money.
So there’s no need to join the silly tax avoiders who dabble in dubious schemes. Your pension is a perfectly legal way to protect more of your money from the tax man, so why not make the most of it? Maybe you won’t retire to Rio – but you can certainly retire much more comfortably.
Find out more about pensions and other tax-efficient ways to save here.
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