Pension savings: through the stages

Despite all the regular changes you will probably have read about, pension saving remains a highly tax efficient way of accumulating wealth; either for your own retirement or (if you find you don’t need it when you get there) for your family’s long-term benefit as well.

Our financial planning expert Poppy takes a closer look at pension savings through three key stages: Contribution, Accumulation and Decumulation.

Stage 1: Contribution

You can contribute up to £40,000 p.a. and you are entitled to UK tax relief on this up to 45%. If you are making the contributions yourself, for example to a self-invested pension plan (SIPP) then expect to receive tax relief at 20% at source i.e. if you are making a contribution to your pension of £1,000 then will actually pay £800 and your pension administrator will claim the other £200 back from HMRC.

Then if you pay income tax at 40% or 45% you will have to reclaim the additional relief yourself. If you are in your employers’ pension scheme, then tax relief is given at source (before you pay income tax on your salary) right up to 45% if you pay tax at this rate and so you shouldn’t have to do anything more.

Now a few rules of the road; if you do not have any earned income then you can only make contributions of up to £3,600 p.a. In fact, it’s a little better than that as again you make the contribution net of basic rate tax i.e. for a £3,600 contribution you actually pay £2,880 — again your pension administrator does the rest.

The contribution can be made by someone else on your behalf including grandparents contributing on behalf of their grandchildren. If your total income is over £240,000 p.a. then the amount you can contribute is restricted all the way down to £4,000 p.a. once your income hits £312,000 p.a.

Stage 2: Accumulation

The good news is that pension savings grow pretty much without tax — no income tax or capital gains tax to worry about (ignoring tax credits on dividends and some foreign taxes which are generally not refundable.) Compounding without tax is powerful; remember the rule of 72 which says that if you divide 72 by your assumed annual growth rate then that gives you the number of years that’s takes for a capital sum to double. For example, at an assumed growth rate of 6% p.a. it will take 12 years for your initial capital to double.

Now if you remove the drag of taxation — say an average of 20% p.a. of the return you can see that a tax-free fund will grow far quicker than a taxable fund. If you reduce your effective initial capital contribution by up to 45% to consider the initial tax relief you may be entitled to, then you can see that the compounding effect is even more impressive.

We will look at this compounding effect in more detail in a future article.

Stage 3: Decumulation

Thankfully there is now far more flexibility in the way you can take your pension benefits. Everything changed with the arrival of flex-access drawdown in 2015 which allows you to use your pension savings held in a personal pension / SIPP — (this doesn’t apply to defined benefits or occupational schemes) a bit like a savings account once you get to 55. You can draw up to 25% as a tax-free amount either in one go or gradually over time and you can also draw out as much or as little of the remaining 75% whenever you want; it is simply added to your income for the tax year, and you pay tax according to your tax rate for that year; as simple as that.

If you don’t use all your pension fund before you die, then the balance can be left to your family members or whoever else you may nominate. If you die before age 75, then the balance can be left free of tax and if you die after 75, then the balance is taxable as income on the beneficiaries of the pension whenever they draw down on it but importantly the remaining pension fund can stay invested and continues to accumulate largely tax free until it has all gone — a so-called long-term family pension.

Again, there are a few traps to watch out for mainly around the so-called lifetime allowance (currently £1.073m) which puts an overall cap on the amount of pension savings anyone can accumulate before they start to run into penalty tax charges — but that and the complexities that surround it — will be subject of a future article.

Rosecut can help you with any of the above, either directly or through our comprehensive professional network so please drop us an email us at for more information and support.

Please note: Past Performance is not a reliable indicator of future returns. When investing, the value of your investment may rise or fall and there are no guarantees you will get back all the capital you have invested.

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