Pensions are great benefits for employees and have been part of the remuneration package for decades. It’s important to make sure that you’re getting the most out of your pension by making use of the various tax reliefs available. In a recent webinar Pensions (July 2023) Jo Marshall offered insight into the topic.
Pensions are a form of savings scheme that allows individuals to put away money for their retirement. The government encourages this practice by offering tax relief on pension contributions. Essentially, this means that when you contribute to your pension, you don't have to pay tax on that portion of your income. However, Jo Marshall cautioned, it's important to note that while you save on tax now, you will be taxed when you start drawing your pension in retirement.
In the webinar, Jo focused on two main ways tax relief is applied to pensions: through a net pay arrangement scheme or a relief at source scheme.
Net Pay Arrangement Scheme
In a net pay arrangement scheme, your pension contribution is deducted from your salary before tax is calculated. This means you get immediate tax relief at your highest rate. For example, if your gross pay is £2000 and your pension contribution is £100, your taxable pay becomes £1900. This scheme is particularly beneficial for high earners who pay 40% or 45% tax. However, for those not paying taxes, there's no tax relief on pension contributions. To address this issue, the HMRC has proposed a bonus payment system, set to be implemented in the tax year 2024-25.
Relief at Source Scheme
On the other hand, a relief at source scheme works differently. Here, your pension contribution is deducted from your net pay, after tax has been calculated. The pension provider then claims basic rate tax relief (20%) from HMRC and adds it to your pension pot. This scheme is beneficial for low-paid workers as they receive tax relief regardless of their tax status. However, higher-rate taxpayers must claim additional relief through their tax returns.
Another concept worth mentioning is the salary sacrifice scheme, also known as 'OpRA' since its introduction in 2017. In this arrangement, you agree to a lower salary in exchange for certain benefits, such as pension contributions. This reduces your overall salary, leading to less tax and national insurance payments. However, this isn't a decision to be taken lightly as it usually involves a 12-month lock-in period.
Understanding how tax relief applies to your pension can help you make informed decisions about your retirement savings. Whether it's a net pay arrangement, relief at source, or a salary sacrifice scheme, each has its own advantages and potential drawbacks. Always double-check with your pension provider or seek professional advice to ensure you're making the best choice for your circumstances.
To watch the full session, click here. In the session, Jo Marshall covers the above as well as the following topics:
- Automatic enrolment process
- Qualifying earnings, pensionable pay and the earnings trigger
- Using postponement
- Handling opt-ins, opt-outs and cessations
The contents of this article are meant as a guide only and are not a substitute for professional advice. The author/s accept no responsibility for any action taken, or refrained from, as a result of the material contained in this document. Specific advice should be obtained before acting or refraining from acting, in connection with the matters dealt with in this article.