Will I pay tax on my pension pot?

Posted on: 02 March 2015 by 50connect editorial

When you retire you will pay tax on the money you receive from your Workplace Pension or state pension if your combined annual income is above your personal tax allowance.

Changes to the law with the introduction of what’s known as “Automatic Enrolment” mean that you could get extra money from your boss paid into your pension pot each month.

And pensions are by a long way the best savings deal around for you as the tax relief is second to none. Over time, the money you build up as tax relief on your pension contributions can be quite significant.

For every £80 you pay into your pension, HM Revenue & Customs (HMRC) will add £20 in basic rate tax relief. This means that the bigger the contributions you make, the more money you are able to get off the tax man.

You could get tax relief on your pension contributions of up to 100% of your annual earnings.

Pensions win

It means that your pension is be by far the most tax efficient investment vehicle available to you.

For example, if a working, basic rate tax payer was to contribute £15,000 to a pension, and the money was invested in underlying assets achieving 6% growth per year, then the retirement pot would be worth £43,406 after 25 years. The same investment would be worth only £34,725 if it was invested in an ISA.*

As well as receiving the up-front tax relief from HMRC, while your funds are in the pension scheme they are not subject to income or capital gains tax. 

Lump sums

Currently, you are also able to take a maximum of 25% from your pension as one single lump sum, tax free payment.

From April 2015, sweeping changes under pension reform designed to give people more flexibility and control over their pensions mean that the over 55s will be able to take a number of smaller lump sums from their pension pot, with 25% of each sum being free of tax.

So instead of just being able to take one lump sum at retirement you will be able to take various tax free lump sums on different dates.

As long as you don’t choose to take more than 25% as a lump sum in one go, you should always have a large tax advantage from your pension.

Income tax

When you retire you will pay tax on the money you receive from your Workplace Pension or state pension if your combined annual income is above your personal tax allowance. For most people, the tax free income limit is around £10,000 per year.

If you do pay income tax on the money from your pension, then taking a number of tax free lump sums could be a particularly attractive option.

Icing on the cake

The good news is that employers are required to make contributions to pension schemes as part of changes in the law with the introduction of what’s known as “Automatic Enrolment.” It’s hassle free for you as your boss takes care of all the admin.

Automatic Enrolment means that every employer must automatically enrol workers into a Workplace Pension scheme if they are aged between 22 and state pension age, earn more than £10,000 a year and work in the UK.

Employers will need to make regular payments into the pension schemes of all those who are automatically enrolled as well as all those workers who choose to opt into the scheme.

If you choose to opt out you could be turning down extra money from your boss.

*Source for figures: Hargreaves Lansdown (adjusted for 2.5% inflation)

 

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