Some of the tax benefits of pensions are...
1) Tax relief on contributions
The taxman effectively pays you to contribute into a pension by giving 'tax relief' on the money you pay in. They will always add 20% in tax relief to your pension, subject to the contribution limits.
For example, if you make a net personal contribution of £80 the government will add £20 to make the total (gross) contribution £100.
A 'gross' £100 contribution will cost you less, as follows:
|Non-taxpayer||Basic Rate Taxpayer||Higher Rate Taxpayer|
Higher rate taxpayers can claim their additional 20% tax rebate via their tax return or PAYE.
It's really important to factor in the added tax relief when making your pension contributions.
To receive tax relief you need to ensure that you do not contribute any more that 100% of your earnings after tax relief has been received, or £3,600 if this is greater. This is subject to the annual allowance of £40,000.
2) No tax on growth within the pension
A pension is a tax efficient wrapper, meaning your investments can grow free of tax within a pension.
3) Tax-free sum at retirement
When you take a pension income at retirement you can withdraw up to a quarter of your pension fund as a tax free lump sum. However, pension income after that point will be be taxable as income.
Please note that there is a maximum amount that you can have in all of your pensions together over your life without incurring a tax charge - this is called the Lifetime Allowance.
The current Lifetime Allowance is £1,055,000 (2019/20 tax year).