Make the most of a tax giveaway while you still can

With the arrival of a new Government, all eyes are focused on what we might expect from Sir Keir Starmer and his newly chosen cabinet. The new Chancellor, Rachel Reeves, has announced that there will be a Budget this year, although with the required ten weeks' notice it is unlikely we will see anything until at least mid-September at the very earliest. 

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It has been suggested that Labour, at this point, have been ‘light’ on the details of what we may expect and there continues to be some concerns around possible changes to pensions , although for now we can be assured that the Lifetime Allowance will not be reinstated as was confirmed earlier this year. However, Labour have confirmed they are planning a full ‘pension review’, so w e have to wait and see what may materialise. 

The current state of play sees us with an increasing tax burden. From a reduced Dividend allowance, falling to £500 - just 25% of the allowance from two tax years ago - to the Capital Gains Tax (CGT) allowance that has reduced from £12,300 to £3,000 over the same time period. We have also seen a freeze in the Savings and Inheritance Tax (IHT) allowances and no increase in the personal income tax bands in England and Wales for years. 

Following a prolonged period of strong wage growth, more and more individuals are pushed into a higher income tax bracket, wiping out much of the value of higher salaries. This is made worse with reduction in the level at which you fall into the additional rate tax band of 45%, falling from £150,000 to £125,140 in April 2023. 

It is suggested that the freeze on allowances is likely to remain, but with this increased tax burden, tax relief on pensions is still the one major perk which has not yet been raided. Will this all change later in the year following a Budget? We will have to wait and see. The advice so far is you can only work with the information you know today, so now is a good time to utilise this benefit, especially if we may see a change in the near future. 

Take advantage of the ‘tax giveaway’ 

The tax relief you gain from contributing to your pension is effectively a ‘tax giveaway’. The tax relief granted on pension contributions is relevant to the level of tax you pay on your income. In real terms, for every £1 a higher rate taxpayer puts into their pension, they effectively only pay 60 pence for that £1 contribution due to the 40% tax relief it would attract. Whereas, an additional rate taxpayer will pay 55 pence for every £1 contribution, as a 45% taxpayer. A basic rate taxpayer therefore pays 80 pence for a £1 contribution. 

For example, Sally is a higher rate taxpayer earning £95,000 per annum from her full-time employment. She currently makes no employee pension contributions but has surplus income at the end of each month and wants to ensure that she saves this money efficiently for her future. If Sally were to make a £20,000 net contribution into her pension, HMRC would top up her contribution by 20% at the outset (via a method called Tax Relief at Source) meaning a total of £25,000 is invested in her pension. As a higher rate taxpayer, paying 40% tax, Sally would be able to complete a self-assessment tax return to claim a further 20% tax relief. Meaning that her pension contribution of £25,000 gross would have only cost her £15,000. Bear in mind, if you do not apply for the additional tax relief, you will not receive it. Therefore, it is vital you remember to include it on your self-assessment tax return.

For those tipping into a higher tax band, there is an additional benefit as you can offset your income tax and avoid being dragged into a higher rate tax bracket. 

Under current legislation, any money invested within a pension can grow free of Capital Gains Tax, making a pension contribution the most profitable and the most tax efficient way of saving for your future. Furthermore, the annual pension allowance was increased this year from £40,000 to £60,000, allowing higher and additional rate taxpayers to save more per year to make the most of the tax relief available. 

What happens when you drawdown on your pension? 

Sadly though, it’s not all good news. As you begin to drawdown on your pension wealth, there are a few things to consider. Firstly, the money you invest within your pension is ‘locked away’ until age 55 (if you joined a scheme before 4th November 2021 and had an unqualified right to retire at 55) or age 57 (if you joined a scheme after 4th November 2021). Current pension legislation with most modern pension arrangements means you can draw up to the greater of 25% of your pension, or £268,275 tax free (the new cash lump sum allowance). When you draw upon the remaining amount of pension wealth, you will be taxed at your marginal rate of income tax. 

If you feel that you are not making the most of your tax allowances, get in touch with a member of our team at The Private Office to arrange a free initial financial consultation.

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions. 

The Financial Conduct Authority (FCA) does not regulate tax advice or estate planning. 

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

The information contained within this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.