Pension schemes and tax relief
A pension is one of the most tax-efficient ways of saving for retirement. Pension schemes that are registered with HM Revenue & Customs (HMRC) can qualify for tax relief on:
- Pension contributions
- Investment income and gains
- Some lump sums paid from the scheme
Contributions
When you make a payment into your pension you receive tax relief from HM Revenue & Customs (HMRC). The effect of tax relief on pension payments over time can be considerable.
Tax-efficient growth
Your pension fund grows largely tax-free, which can help to boost the amount you have in your fund.
Tax-free cash
When you take your benefits you can usually take up to 25% of it as a tax-free lump sum. The remainder of your benefits will be paid as a taxable income.
Tax relief on contributions
For top rate taxpayers you can receive up to 45% pension tax relief for this tax year (2014/2015) when you make a contribution to a pension.
For example:
- You contribute £32,000 into your pension.
- The government adds £8,000, to make a total investment of £40,000.
- Higher and top rate taxpayers can then claim back additional tax via their tax return. £40,000 in a pension could therefore effectively cost a 40% rate taxpayer £24,000 and a 45% rate taxpayer £22,000.
Are there limits to how much tax relief you can get?
The maximum amount that you can contribute to your pension each year and qualify for tax relief is the equivalent of 100% of your taxable earnings (called net relevant earnings), subject to an annual limit and lifetime limit. The annual limit is £40,000, this is increased by any unused allowances from the previous three years, the overall lifetime limit for your pension pot of £1.25m, these are the limits for the tax year 2014-15.
Self invested personal pensions (SIPPs)
Like all pensions a SIPP offers tax relief to your marginal rate of tax and there is no capital gains tax or further income tax to pay. They are specialist products that allow you more flexibility over where your money is invested and are suited to individuals who want to make their own investment decisions.
Anyone can take out a SIPP. Even if you are already contributing to another pension, such as an occupational (company) pension scheme, you can also put money into a SIPP at the same time providing you don’t exceed the maximum pension contribution limits. You can also transfer previous pension policies into a SIPP to consolidate retirement savings in one place.
A SIPP can hold a wide variety of investments, from investment funds and individual shares to commercial property and futures, picking the investments yourself rather than having your provider do this for you.
Small self-administered pension schemes (SSAS)
A SSAS is ideally suited for shareholding directors of small to medium sized limited companies. A small self-administered pension schemes is a workplace pension scheme where the members are normally company directors or key staff, a SSAS usually has less than 12 members and, in some cases, all the members are trustees. Administration fees are usually paid by the company and are tax deductible.
The members and the employer have more flexibility around and more control over the scheme’s investments than you do in other workplace pension schemes. For example, subject to certain rules and conditions set by HMRC, the Trustees can invest in a wide range of assets:
- earn money by loaning money to your employer;
- borrow money to invest;
- invest in a broader range of investments than other schemes, including some highly specialised investments; and
- invest in your employer’s shares.
There is no necessity for all members of the scheme to be employed by the same company provided the scheme is originally established by a company for the benefit of one of its employees.
SSAS are regulated by The Pension Regulatory.
How can I invest in property via a SIPP or SSAS?
One of the attractions of a SIPP and SSAS is that they can be used to invest and develop commercial property, such as offices, industrial units or shops. Your pension fund does not even have to be large enough to buy a property outright as you can borrow up to 50 per cent of the fund’s net value.
Taking the previous example, if you contribute £40,000 to a pension fund, you could borrow another £20,000 to buy a property for around £60,000. So for a 45% rate taxpayer a £60,000 property can be acquired for a net after tax pension contribution of £22,000 plus fees and commissions which may be charged by the scheme and professional advisors. The rent from the property can be used to cover the mortgage repayments, if there is no mortgage, the rent will remain in the pension fund and can be used for other investments. The rent paid into your pension fund from the property is free of tax and there will be no capital gains tax to pay when it is sold within the pension fund.
What happens to my pension fund when I retire?
From age 55, you can usually take up to 25% tax-free cash from your pension fund and a taxable income from the rest. From April 2015 you should be able to take as much of your pension as you wish as income or even as a lump sum, the first 25% would be tax free with the remainder subject to income tax. If you die before age 75 and before you start drawing your pension, your beneficiaries can receive the proceeds of the sale of the property free of inheritance tax.
The exact tax benefits will depend on your circumstances and tax rules are subject to change by the government. We do not give financial advice, nor do we advise on the suitability of a SIPP or SSAS, no comments here are intended as such. Before taking any action you should consult a qualified financial and/or tax adviser.
