How can I save for the future with pension contributions?
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I have recently earned a pay rise giving me a £70,000 salary and a company car that gives me a benefit in kind of £10,000. I understand that if I contribute more to my pension fund from my income into my work scheme, I might pay less tax. I currently contribute 8pc with a matching contribution from my employer. Can you explain how that works, please?
Matthew Beck of Smith & Pinching responds:
Pension contributions are a hugely tax-efficient way of saving for the future, particularly if you are a higher or additional rate taxpayer. Tax relief is granted on pension contributions, adding value to your contributions and reducing your “adjusted net earnings” for tax purposes. Adjusted net earnings are your normal earnings minus the gross contribution into your pension and any gift aid donations.
Essentially, the value of your contribution is added to your personal allowance for income tax. If, for example, you (as a higher-rate taxpayer) made an additional £5,000 contribution into your pension, the additional tax relief you would get would be 40pc of the gross contribution, so £2,000.
Under tax rules, the personal allowance for income tax purposes is reduced for adjusted net earnings of more than £100,000. For those earning more than this, it’s more important than ever to manage your taxable earnings using pension contributions.
The mechanics of how the tax relief is implemented will depend on how you and your employer handle pension contributions. If your contributions are paid “at source” – i.e. deducted from your pay after tax has been paid – you will get the relief either as a payment from the tax office into your pension fund or via your self-assessment tax return. If contributions are taken as part of a salary sacrifice scheme, the value of the gross contribution is deducted from your pay before tax is deducted.
As you can see, the process involves complex calculations in terms of tax savings. However, your decisions at this stage shouldn’t just be about reducing your potential tax bill. Pension planning should also take into account your needs and aspirations for your retirement and plot a route to achieve them. I think it would be useful for you to meet with a Chartered Financial Planner to come up with the right strategy that will give you both tax-efficiency and the means to achieve your long-term goals.
There’s another discussion to be had to examine whether or not your workplace pension scheme is the right place for your additional contributions. A Chartered Financial Planner can help you assess its suitability and recommend alternatives, if necessary.
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Any opinions expressed in this article do not constitute advice. The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
For more information, please visit www.smith-pinching.co.uk