Saving into your pension is not only important to secure a comfortable retirement lifestyle, but can also unlock tax relief that boosts your savings and benefits you in the here and now. Mark Norman explains more.

How to reduce tax by increasing pension contributions and retirement savings - Matthew Douglas

Whatever stage you’re at in your career, it’s never too early to start planning for your retirement. Of course, the main benefit of retirement saving is ensuring that you have a comfortable income to live off once you’ve stopped working.

However, by being savvy with your pension contributions, you can also reduce the amount of tax you pay. That’s because all the money you pay into a pension qualifies for tax relief. 

What is pension tax relief?

Pension tax relief is a government incentive to promote retirement savings by allowing your pension provider to reclaim tax from HMRC and add it to your contributions, effectively boosting your savings. 

The amount of tax relief you receive is based on your income tax rate, with basic rate taxpayers getting 20%, which means each pound contributed becomes £1.25. Higher-rate taxpayers receive 40% (turning every pound into around £1.66), and additional rate taxpayers get 45% (effectively an 80% boost). However, higher and additional rate taxpayers must claim this additional relief through their tax return.

In essence, pension tax relief offers a substantial financial advantage, making pensions a compelling investment choice for long-term savings, especially for high earners. In some cases, higher-rate taxpayers can put money into their pensions via salary sacrifice and reduce their taxable income to below the higher-rate threshold, making them even more tax efficient. 

Things to consider

While maxing out your pension contributions is generally a good idea for a lot of people, it’s not necessarily always the best thing to do. It’s important to consider that your money will be locked away and, from 2028, you will need to be 57 to access a private pension. If you have high-interest debts like credit card debt, it’s advisable to prioritise paying them off first before maxing out your pension contributions.

It is, however, important to start saving into your pension as early as you can, even if it’s just a little bit per month to start with, to avoid playing catch up later. Auto-enrolment schemes offered by employers are a convenient way to begin saving for retirement, but it’s worth noting that they may not provide sufficient savings as the amount needed for a comfortable retirement can be surprisingly substantial.

Lifetime ISAs 

A Lifetime ISA (Individual Savings Account) is another option that offers tax savings for those looking to save towards their retirement. Just like other types of ISAs, Lifetime ISAs are tax free.

They can be opened by those aged 18 to 40 and you can contribute up to £4,000 annually until age 50, with the government providing a 25% bonus, capped at £1,000 per year. 

Once you reach 50, contributions and the 25% bonus cease, but your account remains open and continues to earn interest. You can then access your savings from your Lifetime ISA at age 60 without incurring penalties. Withdrawing funds or transferring the account to another ISA type before then will result in a 25% charge. 

Lifetime ISAs are cheap and simple investment solutions, and are very easy to set up, with many banks and providers allowing you to open them via an app. People tend to have a Lifetime ISA in conjunction with a pension so you can essentially max out your tax relief. 

At Matthew Douglas, our team of retirement planning experts are here to help you ensure your pension and savings are right for you. Get in touch with us to discuss your options.