Pension is your secret weapon in war on taxes

WHILE the nation waits to hear whether Chancellor Jeremy Hunt will grant us a tax cut or two in next month’s spring Budget, financial experts say there is plenty people can do to cut their tax bill today.

Pensions are the secret weapon in your tax-fighting armoury, and can be used to reduce your annual HMRC bill while also boosting your retirement pot.

Dean Butler, managing director for retail direct at Standard Life, said the end of the tax year on April 5 is close but there is still time to swing your pension into action.

Everyone can invest 100 per cent of their annual earnings in a pension and claim tax relief, up to a maximum £60,000.

This is called the annual allowance and if you have maxed out this year’s total, you can usually carry forward any unused allowance from the previous three tax years.

Tax relief on pension contributions makes this one of the most tax-efficient ways to save for retirement, Butler said.

Government-funded top-ups mean basic rate taxpayers pay £80 for each £100 that goes into their pension. This falls to £60 for 40 per cent taxpayers, who must claim the additional relief via a self-assessment tax return.

Payments into a workplace pension also attract tax relief and get a further boost from employer contributions.

Under the auto-enrolment scheme, employees contribute 4 per cent of their income, with employers paying 3 per cent while 1 per cent tax relief lifts the total payment to 8 per cent.

If you pay more, some workplaces will match it, so check with your employer.

Anyone who gets a work bonus should consider paying it into a pension. “This could save on income tax and National Insurance (NI), so you ultimately keep more of your bonus.”

Paying extra contributions could also reduce your income so that you fall into a lower tax band and pay less to HMRC. This is a valuable benefit as Hunt freezes income tax and NI thresholds all the way to 2028. Anyone who reduces their annual income below the £12,570 personal allowance pays no tax at all, while there are huge benefits for those earning more than £100,000.

They lose £1 of personal allowance for every £2 of income above that threshold, until it vanishes altogether once their income tops £125,000.

This is an effective tax rate of 60 per cent but you can reverse this by paying the surplus income into a pension. “That’s quite a significant pension perk.”

Paying into a pension can also help families combat the high income child benefit charge, which steadily reduces the benefit once one parent earns £50,000. At £60,000, the charge wipes it out entirely.

People can take money from their pension once they are 55. Withdrawals will be added to total earnings and may be subject to income tax.

Once people start making pension withdrawals their annual allowance will fall from £60,000 to just £10,000.