Did you know that pension contributions will significantly reduce your taxable income? Discover the powerful strategy that could save over 55s a significant amount on their tax bill.
(5-minute read)
We will cover:
- How much you can save with pension contributions
- Tax legislation on pensions
Introduction
The latest estimates from HMRC and the Office of National Statistics (ONS) reveal a challenging picture for paid employment this year.
In his Budget speech, the chancellor drew attention to the fact that over seven million working-age adults were not in work, except for students.
Unfortunately, the latest statistics show that the number of individuals in payrolled employment is decreasing, with almost 90,000 less at the end of March 2023 compared to the turn of the year.
On the positive side, workers aged 65 and over have seen a significant increase in payrolled employment, with over 2% growth since the start of the year.
This trend has continued since the beginning of 2020, making this age group the fastest-growing with almost 19% growth.
One reason for this could be the lower effective tax rate for older workers, as those over the state pension age are not required to pay employee’s national insurance contributions (NIC), leading to an effective tax cut of 12% on earnings above £12,570.
Pension contributions
In line with the chancellor’s plan to encourage those over 50 back into work, changes made to pensions in the Budget mean that many over 55 could pay very little overall income tax on part-time earnings of £20,000 per year.
An increase in the money purchase annual allowance allows those who have already flexibly accessed their pension benefits to contribute up to £10,000 per year from 6 April 2023, up from the previous limit of £4,000.
Some employers offer a pension salary sacrifice scheme, enabling employees to contribute part of their gross pay to their pension pot.
Depending on the amount, this contribution may be free from income tax and both employers’ and employees’ NIC.
Some employers match or top up the pension contributed by the employee due to the savings on NIC.
Example
To illustrate, an employee over 55 earning £20,000 with no current pension contributions would have a net take-home pay of £17,622.
However, an employee benefitting from a pension salary sacrifice scheme, with an employer willing to top up the employee’s pension pot by the employer’s NIC saved, could sacrifice £8,787 of salary and receive an employer pension top-up of £1,213.
This would result in the employee having £11,213 of taxable salary remaining and £10,000 in their pension pot.
The remaining salary would be free from income tax and NIC within the personal allowance, and the individual may also access the funds paid into their pension as an uncrystallised funds pension lump sum (UFPLS).
If the individual accesses £10,000 of their pension pot in this way, they could receive 25% tax-free within the relevant limits, resulting in a net take-home pay of up to £19,984 and an effective tax rate of 0.08% on their original £20,000 salary.
Employers should be cautious not to breach national living wage limits by allowing employees to sacrifice too much of their salary as pension contributions.
Additionally, once an individual starts accessing their pension, tax relief can only be claimed on £10,000 per annum of any further contributions.
However, these savings may be attractive to those over 55 looking to return to the workforce, subject to further consideration of the details.
Salary v salary and pension comparison
| Salary alone | Salary and pension | |
| Salary | £20,000 | £20,000 |
| Employer NI | £1,213 | |
| £20,000 | £21,213 | |
| Tax and employee NI | £2,378 | £1,229 |
| Net receivable | £17,622 | £19,984 |
As you can see from the table above, the employee from the previous example will be £2,362 better off by making pension contributions!
Key facts
In conclusion, one of the key benefits of making pension contributions is that they can reduce your taxable income.
This is because pension contributions are deducted from your gross pay before income tax is calculated, which means that you pay less income tax on the remaining amount.
Keep in mind that the amount of tax relief you can claim on their pension contributions depends on your tax bracket:
- If you’re a basic rate taxpayer, every £1 you contribute to your pension will attract 20p in tax relief
- If you’re a higher or additional rate taxpayer, you can claim 40p and 45p respectively for every £1 you contribute
It’s important to note that there are limits on how much you can contribute to your pension each year while still receiving tax relief:
- The annual allowance for pension contributions is currently set at £60,000, although it can be lower for higher earners or those who have started drawing down their pension
- If you’ve already started drawing down your pension, you may also be subject to a money purchase annual allowance (MPAA), which limits the amount you can contribute to your pension while still receiving tax relief
- The MPAA is currently set at £10,000 per year, although this may be increased for those who have accessed their pension flexibly
Some employers may offer a salary sacrifice scheme, which allows employees to exchange part of their salary for an equivalent amount of pension contributions.
This can be a tax-efficient way to boost retirement savings, as the salary sacrifice amount is deducted from an individual’s gross pay before income tax and national insurance contributions are calculated.
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