Pension Contributions – A tax-efficient investment?

Whether employed, self-employed or trading through a limited company, pension contributions can be a very efficient way of lowering your tax liabilities.

Pension contributions and income tax examined

Depending on your status as a basic, higher or additional rate taxpayer, the Government will automatically uplift your pension contributions by 25% to 67%.

Who even knew?!

A research report commissioned by the Government in 2016, whose findings have only just been published tells the following disappointing story.

• People with pensions were asked how much the Government contributed to their pension fund. The mean response from basic rate taxpayers was 8% and the mean response from higher or additional rate taxpayers was 18%. The correct answers are 25% and approximately 67%.
• Only 38% of people find their pension statements of interest, while 41% don’t remember receiving a statement in the last 3 years or even reading them. And 19% don’t find their pension statement helpful.

Pension choices

People were asked what would encourage them to increase their contributions.

• A flat rate government top up contribution of 30%? 28% said yes they would feel encouraged to increase their contribution.
• A flat rate government top up contribution of 20% and a tax-free income from their pension? 34% said yes they would feel encouraged to increase their contribution.
• But the majority who responded said that neither option would make them save more into their pensions.

59% of responders did not know about the annual contributions limit, and 66% did not know about the lifetime allowance (which stands at £1.073m in 2022). This is perhaps unsurprising as it will only benefit higher earners who are in any case, a smaller percentage of the working population.

The findings confirm a lack of knowledge and interest in pensions, but also a lack of clarity in a complex financial area. People are not necessarily interested in which options would give them more income, but in having a system that is simple and they can understand the relationship between what it costs them today to achieve what they require tomorrow. With the potential for a pension pot raid at every budget, there’s also a strong argument that a bird in the hand is worth two in the bush.

We don’t all have the foresight of clairvoyants, nor the analytical skills of actuaries to balance how much we can afford today and how long we need our pensions to last at a level we can enjoy. But everyone should really take more interest in their own financial future, and optimize their tax situation wherever they can.

Next steps

If you would like to discuss any aspect of tax planning with one of our tax advisors, please do get in touch.

More information

You can browse the whole HMRC research report here – Pension tax relief: awareness, understanding and saving behaviours