Your pension is one of the most tax-efficient investments. As the current tax year draws to a close, you could find that there are several ways of adding to your pension. Before the current tax year ends, it is time to calculate whether or not you can claim back and tax relief, and to see if you can use previous year’s allowances to increase your pension contributions.
Your pension contributions qualify for tax relief, meaning that the taxman will add 20% of your contribution on top. If you are a higher rate taxpayer, then on top of the taxman’s contribution, you can also claim back 20% of your pension payments. For every £80 you contribute towards your personal pension, you can claim back £20, meaning that effectively your pension contributions have cost you less each month.
This also works if you have a company pension, although the system is slightly different. If you pay the basic rate of tax, you receive 20% tax relief for every £100 that you pay in to your pension, meaning that for every £100 that is deducted from your wages each month towards your pension, your take home pay is only reduced by £80. If you pay a higher rate of tax, this percentage goes up to 40%, meaning for each £100 contribution, your take home pay is reduced by £60.
However, unlike a company pension, where your tax relief is automatically paid in to your pension, if you have an individual pension and are paying a higher rate of tax, you have to claim back your extra tax relief. To do this you need to fill out a self-assessment tax form and return this to HM Revenue and Customs before the end of the tax year. There are many places offering free tax relief calculators online, including the HMRC website.
Currently, the maximum amount you can pay into your pension each year and still receive tax relief on top of it is £50,000. Once your contributions go above £50,000, you will have to pay an annual allowance charge. As well as losing tax relief, you will have to pay tax on these payments. This is calculated by adding the amount of contribution exceeding £50,000 on to your yearly income to find out which tax band you fall into. The percentage of that tax band is then deducted from your pension savings in tax.
However, if in previous years you have not used the full £50,000 allowance to pay into your pension, you can use the carry forward rules to add up to three previous years’ unused allowance to this year’s allowance. So for example, if each year for the past three years you have only paid in £40,000 to your pension, you could add £10,000 of unused allowance for each of those three tax years to your current allowance. This would mean that this year you can pay up to £80,000 towards you pension and receive tax relief on this.
Using the three year carry forward rule, you can effectively reduce the amount it costs you to contribute to your pension. Remember to act quickly though if you are in a position to do this, as when the current tax year ends, you will lose one of those years of extra allowance. If this was a large sum – for example if you only contributed £15,000 to your pension three years ago, giving you £35,000 of allowance that could be added on to this year’s – you will need to act now before that benefit is lost to you.
If you haven’t got a pension scheme yet, you can still benefit from this by registering for one now and then claiming back the unused allowance in the next tax year. Whether or not you have a pension, you need to be on a registered pension scheme, rather than personal savings, in order to qualify for the carry forward rule.
The current tax year is drawing to an end, but there is still time to add to your pension. Tax relief can be claimed back, reducing the amount you actually had to spend in order to contribute to your pension, and by carrying forward unused allowance from previous years, you can greatly increase the amount of contribution that qualifies for tax relief. Depending on your rate of contribution over the past three years, this could be a sizeable sum.
|Written by :|
|Jemma is a news & research reporter for compareandsave.com.
Having worked as a journalist on a number of personal finance websites; she now spends time researching and commenting on UK personal finance stories and investigating new ways to help our readers save money.
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