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Do you have a lump sum to invest into your pension?

Sep 17, 2018 | pensions, retirement

Invest in your pension at the high earning rate to maximise your tax relief
You can put money into a pension even where you belong to a work pension scheme: the only limit currently applying is that savers do not exceed the annual maximum contribution of £40,000. Anyone who hasn’t maxed out their employer’s pension contribution should do so as this will give you a double whammy, getting extra money from both the taxman and also your employer.

Any money you pay into your pension fund, the pension provider will claim the basic-rate tax relief direct from HMRC and add it to your account. If you a higher rate tax payer you’ll get 40 pence back for every 60 pence you save into a pension. That’s a healthy 67% return and very different to returns on cash savings.

Putting £1 into a pension will only cost a higher rate taxpayer 60 pence.
Depending on how you are paying into your pension will affect how HMRC deals with your money.
A £10,000 initial investment with no tax relief would grow into a £27,126 pot over 20 years at a compounded annual return of 5%.
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By comparison, a £10,000 contribution made by a higher –rate taxpayer and attracting 40% tax relief would turn into £45,209 pot over the same period, given the same investment returns.
The table below shows how much tax relief boosts initial contributions to pensions.

To end up with £10,000 for example a higher rate tax payer need pay just £6,000. The tax relief at 40% makes up the rest.
That works out as an enhancement of 67%-not a bad immediate return, especially as it involves zero risk.

An additional rate tax payer pays just £5,500 to obtain the same £10,000 benefit.

Cost of making a £10,000 pension contribution

Your rate of income tax You pay effective % boost
Basic Rate (20%) £8,000 (25%)
Higher Rate (40%) £6,000 (67%)
Additional Rate (45%) £5,500 (82%)
What the tax boost adds to investment returns

Non-Earners can still benefit

Non-earners, whether adults or children can currently benefit from basic rate tax relief on contributions to pensions of up to £2,880 per year.

The taxman adds the basic tax relief to this (£720 on the maximum annual £2,880), rounding up to a gross pension saving of £3,600.

While the sums are not huge, the 20% uplift could benefit older, non-earning spouses; they could then draw the pension, paying no tax at all (hopefully). The result is that they capture a tidy 20% return at the expense of the tax man risk free. Wealthy individuals have previously used this allowance to invest each year on behalf of children.

Initial investment £10,000, growing at 5% per year compounded:

Level of tax relief After 10 Years After 20 Years
None £16,470 £27,126
Basic Rate (20%) £20,588 £33,908
Higher Rate (40%) £27,449 £45,209
Additional Rate (45%) £29,944 £49,319

Maximise your Annual Allowance

Forward your un-used annual allowance for up to three years. Thus for the tax year ending 5th April 2018 anyone who hasn’t been in the habit of contributing to a pension could use the following allowances:
Tax Year Ending Annual Allowance
5th April 2016 £40,000
5th April 2017 £40,000
5th April 2018 £40,000
Total £120,000
If you’ve recently received an inheritance or have a number of old, poorly performing PEPs or ISAs, contributing £96,000 into a personal pension would give you a top up from the taxman (at 20% rate) to your maximum contribution.

Your annual allowance depends on your circumstances. The rules are nuanced but in headline terms.

1. You can pay in up to £40,000 a year (including tax relief at 20% if not provided at source) or 100% of your salary, whichever is the lower;

2. If you are already taking benefits from a defined contribution pension scheme, the allowance is reduced to £4,000 or 100% of your salary

A different route but again a £1 contribution to your pension will only cost you 60 pence.

Using up the annual allowance your given could be worth an extra £68,000

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