For many of Britain’s self-employed, the end of a tax year can feel like a chore.
Organising invoices, filling in tax returns - it’s a time to reflect on the last 12 month’s hard work and make sure your finances are up to scratch.
But there’s one thing many of us fail to take into account - now is a great time to take advantage of tax relief and reduce your tax bill.
How? Through a little-known ally: your pension.
In this blog, our friends at Penfold reveal how your pension can help you trim your tax and keep more of your hard-earned money.
How pensions reduce tax
Ok, so how can your pension help trim your tax bill?
Every time you pay into your pension, you’ll get to take advantage of tax relief at source.
Any ‘personal contribution’ you make (from a non-business account) benefits from basic rate tax relief from the government - added onto your pot automatically.
Essentially, this works out as a 25% bonus on every personal contribution.
Let’s say for example you add £1,000 into your pension. The government will add an extra £250 - this is because you’ve already paid £250 tax (at the basic rate of 20%) on the £1,000 you contributed into your pension.
Please remember, tax treatment does depend on your individual circumstances and may be subject to change in the future.
The government incentivises people to pay into private pensions by offering vast tax breaks on anything that add up to the yearly limit. As a Penfold pension customer, we claim this tax relief for you without you having to fill any forms.
But that’s just the start.
Extra benefits for higher rate taxpayers
If you are a higher or additional rate taxpayer, you can enjoy even more tax relief.
Your contributions into your pension will automatically receive the 25% tax relief, but because you’re paying higher rate tax above the basic rate threshold, the government will pay back the tax you’ve already paid by offsetting it against your self-assessment tax return.
So, if you contribute into your pension before 5 April, from 6 April onwards you can submit your next tax return and claim back the extra 25% tax relief.
Pay in one day, get money back the next. HMRC will either send this to you in a cheque in the post or take it off your total tax bill.
This means that contributions of £1,000 into your pension will have £250 added on top by HMRC, and you’ll also be able to claim an extra £250 in your self-assessment tax return.
Here’s what that looks like.
How much could my pension save me?
When you’re deciding how much to contribute into your pension each year for tax relief, it’s important to take into account your annual and lifetime allowances.
For most people, tax relief on pension contributions are capped at £40,000 or 100% of your yearly earnings, whichever is lower.
There is also a limit to the value you can save into a pension, called the Lifetime Allowance or LTA. Currently, the LTA is £1,073,100.
It’s important to bear this in mind when you’re contributing into your pension pot. Exceeding this allowance and triggering the 55% charge can cancel out any tax benefits you’ve accrued over the years!
Other ways your pension can help
Chances are, you’ve not considered that your pension could be a nifty way to help balance your personal finances and make sure you’re receiving the allowances and benefits you’re entitled to.
Using your pension to save for the future, and improve your income right now feels too good to be true, but it's not!
Get your personal allowance back
If you’re earning over £100,000 you’ve probably experienced a cut to your personal allowance.
Most people have a tax-free amount they can earn before income tax is applied which is called the personal allowance. For the 2021/22 tax year this is £12,570.
Once you earn more than £100,000 your personal allowance starts to take a hit. It’s reduced by £1 for every £2 you earn. You lose it completely once you earn £125,140.
You might be able to recover some or all of your personal allowance by increasing your pension contributions to reduce what is seen as earned income. You save on tax and benefit from more in your pension pot for retirement.
