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Tax Breaks for Pensions Fact Sheet

Introduction

Successive governments have always been keen for us to save money for our retirement. This means that there are generous tax breaks available for those who do.

Occupational pensions

If you are investing in a company scheme, you automatically receive an Inland Revenue contribution relevant to your earnings.

• If you are on basic rates of tax, this means that for every £80 you pay into a personal pension, the taxman will pay another £20.
• If you are on higher rates of tax, tax relief means that for every £60 you pay in, the taxman pays another £40

Tax-free cash

Until recently, there were complicated rules in respect of how much tax-free cash you could take from a company’s final salary scheme.

Since then, the government has changed the law so that members of occupational schemes can take 25% of their pension lump sums in cash, up to a maximum of £375,000, rising to £450,000 by 2010.

Personal and stakeholder pensions

• Similar rules also apply to personal pensions: for every £100 paid into one, basic rate taxpayers only have to contribute £80. The Inland Revenue chips in the remaining £20, subject to the change referred to above

• Higher-rate taxpayers receive the same tax relief, but can also claim back an additional 18 pence for every pound of contributions when they fill in their tax forms. Or else, they can offset this rebate against other earnings

• Money inside a pension fund rolls up free of tax

• When a personal pension matures, a policyholder can take up to 25 per cent of the final lump sum as tax-free cash

• If you die before retirement, or an annuity is bought with your pension pot, it passes to your estate and may be subject to tax if the total estate is over the inheritance tax (IHT) limits of £325,000, as of April 2008

One exception is if your pension pot is based on contributions from a so-called “contracted-out” pension, made up of a National Insurance rebate (a government bribe for not taking up your entitlement to the Second State Pension, or S2P).

These pensions have a “protected rights” which be used to provide a regular income for your dependents.

Contributions limits

Since April 2006, there is a single “lifetime allowance” on the amount of pension savings that can benefit from tax relief, rising as follows:

2007 - £1.6m
2008 - £1.65m
2009 - £1.75m
2010 - £ 1.8m

This will be reviewed every five years.

An annual contribution limit of up to 100 per cent of relevant earnings (or £3,600 if a person earns less than that) also applies, up to £215,000 in any one year.

There will be special arrangements for people who want to pay in large redundancy cheques and so on.


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