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Dull to dazzling - a pension revolution

The new reforms have made pensions exciting again. Take advantage before they become more restrictive.  

If you still think pensions are boring and something to avoid, then where have you been over the last 12 months? Pensions are now exciting, which is not a description you often hear about a financial product. 

The game changer was the rule allowing savers to withdraw as much of their pension as they want, whenever they want, from age 55. The subsequent announcement that if you die before age 75, you can pass the whole pension on tax-free, was equally sensational. Even after age 75, it can stay in a pension and your beneficiaries will only pay tax on the withdrawals at their marginal rate of income tax. 

In short, the reforms give total freedom to spend as much of your pension as you want while you are alive; and to pass it on to future generations when you are gone. 

Here are a few examples to illustrate just how exciting pensions have become: 

Steve is 59 and has never liked pensions for all the usual reasons. But he is retiring next year and has heard about the changes so is considering making a pension contribution. Steve earns £90,000 and therefore decides to make the maximum £40,000 contribution. He receives higher rate tax relief on it all, so it only costs him £24,000 net. 

When he takes the money out of his pension on retirement - assuming no growth on the fund or other income - the £40,000 will break down as follows: 

£10,000 tax free cash (25%)

£10,600 tax free income (personal allowance), fiscal year 2015-16

£19,400 taxable at 20% = £3,880 

Steve's net income will therefore be £36,120. So Steve paid in £24,000 and got back £36,120 with no growth on his fund at all. An increase of 50% on his money with no risk whatsoever. That is what I call exciting. 

60% tax relief - it just gets better

If you earn £120,000, then unfortunately you have lost your personal allowance. However, by paying a pension contribution of £20,000, your allowance will be restored, which means that the £20,000 in your pension fund would only have cost you £8,003. This gives you tax relief of 60%. 

That is not the only way to get large levels of tax relief. If you are an employed 45% taxpayer and about to receive a £20,000 bonus, you could ask your employer if you could invest it in a pension instead. If your employer was kind enough to also invest the national insurance (NI), they would save as well. The calculation looks like this: 

£20,000 gross bonus

£2,760 employer NI at 13.8%

£400 employer NI at 2%

£9,000 income tax at 45%

£10,600 net bonus 

However, the pension contribution would be the gross bonus of £20,000 plus the employer NI of £2,760 giving a £22,760 pension fund instead of a net cash payment of just £10,600. This equates to 53% tax relief. 

...and better

Not just high earners can benefit. Almost everyone from birth to age 75 should at least consider paying into a pension. 

Steve's wife, who is 60 and has no earnings, could pay in £3,600. This would only cost £2,880 after basic rate tax relief. As she is not using all her personal allowance, she could then withdraw all the money and keep the whole £3,600, pocketing a profit of £720 a year. She is free to do this every year. 

Even infants can pay into a pension. Given the effect of compound growth - which Albert Einstein referred to as one of the wonders of the world - it is well worth considering. 

Whatever your position, high earner or low, old or young, pensions could be the way to put a bit of sparkle into your savings. The rules are only likely to get more restrictive so take advantage while the tax relief lasts.


The examples within this article are based upon specific circumstances and do not constitute advice. If you are interested in discussing this further, please contact your adviser. All information provided is based upon our understanding of current legislation, this is not guaranteed and could change at any time.