Your pension could be the key to a whole load of benefits
We all know that pensions are a great way of saving for your future retirement, but did you know, if you’re a higher or additional rate taxpayer, they can also help you get access to a larger Personal Savings Allowance and allow you to keep more of your Child Benefit?
But let’s go through it and how paying more into your pension could give your money a boost in more ways than one.
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How paying more into your pension boosts benefits and allowances
Some benefits require you to earn below a certain amount, so the more you earn, the more likely it is you’ll miss out. But if you pay enough into your pension it can take you below these thresholds, and as result you may be able to:
- Get the full amount of Child Benefit
- Get the full £1,000 Personal Savings Allowance
- Reinstate your Personal Allowance, if you earn more than £100,000 a year
Now this trick works because paying more into your pension essentially means you’re seen as having a lower taxable income, for the purpose of qualifying for certain benefits. You’ll also be giving your money a boost thanks to tax relief, so it’s a win-win.
However, be aware that as you’ll be paying more into your pension, you’ll likely be taking less of your salary home each month.
Getting access to Child Benefit
If you’ve got kids, Child Benefit pays you £25.60 a week for your first child and £16.95 per week for every other child.
But if you or your partner earn over £60,000, things change. At this point, you’ll have to start paying what’s known as the High Income Child Benefit Charge (HICBC).
This is a fee equivalent to 1% for every £200 of income above £60,000. This applies if either of you earn between £60,000 and £80,000. And once you hit £80,000 you essentially end up paying back all the benefit.
However, even in this case, it’s worth claiming the benefit anyway as it’ll help you earn National Insurance credits, which go towards your State Pension.
But pay more into your pension and you’ll reduce your taxable income (which the Government considers when calculating Child Benefit) and pay less of the HICBC or get rid of it altogether.
Now, depending on how much you earn and how much more you need to pay into your pension to reduce your HICBC, the savings could potentially be quite small. But, if you were planning on boosting your pension contributions anyway (which comes with its own set of benefits), on top of keeping more of your Child Benefit, then it’s definitely worth doing.
And while bigger contributions may feel like a lot of money to be without now, you’ll actually be saving significantly more overall once you factor in the tax relief.
For example, say you earn £68,000 a year and added £8,000 to your pension, it would bring you down to the Child Benefit threshold.
Yes, £8,000 a year is a lot of money but with the 20% tax relief you’d get automatically from HMRC and 20% tax relief you’d get through self-assessment, that £8,000 is actually only effectively costing you around £4,800. Plus you’d get to keep all the child benefit payments.
If you want to work out how much Child Benefit you’re entitled to and how much you’d need to contribute to your pension to reduce the HICBC, you can have a play on the Government’s Child Benefit calculator.
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Boosting your Personal Savings Allowance
When you earn interest on your savings, it’s subject to tax once it’s over your Personal Savings Allowance (PSA).
Basic rate-taxpayers can earn £1,000 in savings interest each year tax-free and anything above this is charged at 20%. Higher-rate taxpayers have a £500 Personal Savings Allowance and pay their usual rate of tax on interest that exceeds this while additional rate taxpayers don’t get an allowance.
Rob Morgan, from investment firm Charles Stanley, says: “By making a pension contribution that has the effect of reducing your taxable income it is possible to increase the Personal Savings Allowance that’s available to you. For instance, if you earn £60,000 and make a £12,000 gross pension contribution you can qualify for a £1,000 PSA rather than £500.”
If you’re wondering about the maths, we’ve used this example as you have to add the interest to your other income before you can work out the tax band for your PSA. So in this example, if you paid £12,000 into your pension, you’d end up with £48,000 taxable income plus the £1,000 savings allowance so £49,000 in total, which is safely within the basic rate tax band.
Rob adds by doing this you could earn tax free interest on more of your savings. For instance, if your savings account paid an interest rate of 5% you’d be able to earn tax-free interest on £20,000 of savings rather than just £10,000.
It’d be a similar story for additional-rate taxpayers who could create a £500 PSA if they add enough to pensions to bring them down into the Higher-rate band.
Gross income v net income
In a nutshell, gross income is your total earnings before any deductions are made – like tax, National Insurance, pension contributions or other benefits.
Net income is what’s left after tax and other expenses are taken out – it’s essentially your take-home pay.
When working out how much tax you pay or what benefits , it’s calculated based on your gross income.
Reinstating your Personal Allowance
As soon as you start earning more than £100,000 a year, you start to lose your £12,570 Personal Allowance. For every £2 you earn over £100,000, you lose £1 of your tax-free Personal Allowance. Losing your Personal Allowance could mean that some of your income could be taxed at an effective rate of 60%.
But, if you pay more into your pension, to take you below this threshold, you avoid the tax trap.
How much can I contribute to my pension?
Most people have a pension annual allowance of up to 100% of their UK relevant earnings or £60,000, whichever is lower, in the 2024/25 tax year and benefit from tax relief on the contributions.
At the moment those same limits will apply in 2025/26.
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Have I got time to add more to my pension this tax year?
Yes, you’ve got until 5 April to make a contribution for this tax year and payments cannot be backdated when it comes to affecting your tax rate.
But be warned
As paying into your pension lowers your net pay, tax and National Insurance contributions, it can impact a number of other benefits you might be entitled to. For example, it may impact contribution based benefits such as the State Pension or Incapacity Benefit and earnings related benefits like Maternity Allowance.
If you contribute to your pension via Salary Sacrifice (which takes your contributions from your pre-tax salary) you’d be viewed as earning less it may also reduce the amount you can borrow for your mortgage and how much life cover you can get.This wouldn’t be the case if you make your own pension contributions ad hoc.
And remember, the money in a pension can’t be accessed until you reach retirement age. This is currently 55 and rising to 57 (and it’ll probably go up again). It means that stashing more money in your pension will be for the long term and might not be suitable for everyone.
However, we know people aren’t putting enough money aside for retirement so increasing pension contributions is a great way to do this while helping reduce tax in the shorter term.
Plus, while your investments in a pension grow tax-free when you take the money out there is usually income tax beyond the first 25% of the pot. This is why people sometimes describe pension contributions as ‘tax deferral’.
However Rob says: ‘”Often people drop a tax band as they move into retirement, though, which is why combined with the tax-free element pensions are typically very tax efficient.”