Pensions benefits you may have missed - The power of tax relief

In the second of our blogs looking at benefits in a pension you may have missed, John Dowding, Technical Director at Morgan LLoyd, considers the power of tax relief.

“Let’s Imagine it’s the end of the tax year and you want to pay one last sizeable personal pension contribution before starting to draw your pension. Let’s say a contribution of £50,000.

Immediate basic rate tax relief of 20% means you only actually pay £40,000, so already you’ve saved £10,000. Good start.

Also let’s assume that you are a higher rate taxpayer – this means that you can claim a further 20% through self-assessment.

Another £10,000 saved. So it has cost you just £30,000 to achieve a pension contribution of £50,000.

Now let’s see what happens in the next tax year if you want to take your pension benefits from this one-off contribution payment? If we assume that you have left employment or have reduced your hours and are now a basic rate taxpayer, how much would you get?

Well, assuming no growth on your contribution, you have £50,000 invested. You can take 25% tax free and the remainder is taxed at your marginal rate of tax.

In other words, £12,500 is tax free.

This leaves £37,500 which is subject to 20% income tax of £7,500.

Therefore the total payment to you is £12,500 plus £30,000. Total payout of £42,500.So for a net payment of £30,000, you have received a sum of £42,500. A princely net gain of £12,500, or just over 41%!!

Compare this to an equivalent net payment made to an ISA. There is no tax relief given going in and no tax paid when drawing out. In other words, £30,000 is paid in and £30,000 is paid out. A net gain of… er… zero.

The conclusion that can be drawn from this is clear enough. Sadly, however it continues to be widely misunderstood how the power of tax relief can powerfully boost your pension contribution from your very first payment right thought to your last."

The information above is based on our understanding of the legislation applicable to UK Registered Pension Schemes, and HM Revenue & Customs rules. It is provided as a summary only and should not be taken as advice - Morgan Lloyd SIPP Services Ltd and Morgan Lloyd Administration Ltd are not authorised to give financial advice and will not be responsible for any decision or action taken as a result of relying on this information. If you are a retail client you should seek financial advice from a financial adviser who is authorised by the Financial Conduct Authority and/or seek guidance from the Government’s Pension Wise service.