Before we start, we'd like to clarify that we aren’t talking about shady tax avoidance deals here, these are incentives that the government has included in the tax system to encourage people to save and invest for the future. These incentives are known as tax relief.
Here are a few of the most popular:
Paying money into a pension
You can make the most of tax relief when planning for your retirement.
Every time you pay into a personal pension, you get money back from the government in recognition of the tax you’ve already paid on those earnings. How much tax relief you get depends on how much you earn. Think of it as a reward for planning ahead and saving for your future.
For basic-rate income tax payers – that’s anyone who earns between £11,501 and £45,000 every year - the level of tax relief is 20%.
That means that if you put £100 into a pension, the government will give you £25 back as tax relief.
Higher-rate income tax payers, who earn between £45,001 and £150,000 a year, get tax relief at 40%, so get £66.66 from the government for every £100 they pay into their pension.
And additional-rate income tax payers, who earn more than £150,000 a year, get tax relief at 45%, so get £88.81 for every £100 they pay into their pension. There are other rules that apply here depending on specific circumstances.
That’s free money, straight into your pension pot, and you don’t have to make any special arrangements – depending on how much tax you pay and the type of pension you have, your pension company will automatically claim the basic level tax relief of 20%, back from the government for you. However, if you are a higher or additional rate tax payer, you will need to claim your additional tax back from the government yourself. Either way, it’s free money in your pocket, so it makes sense to take full advantage.
There is an annual limit on the amount of money that you can pay into a pension and earn tax relief on, which is currently 100% of your earnings up to a maximum of £40,000 a year, and a lifetime limit of £1 million. You will have to pay income tax on any payments into your pension that are over these limits.
Before you contribute to a personal pension, it’s important to check whether you can get free money through your workplace pension!
The minimum employer contribution to a workplace pension is currently 3%, however, some employers may offer to match more than the minimum. It could be worth your while to check whether your employer will match additional workplace pension contributions you make.
Getting money out of a pension
Once you retire, you will have to pay tax when getting money out of your pension.
Your state pension, workplace pension, personal pension and any other money you have coming in during your retirement, (for example from investments or a property you own) all count as income, so you have to pay 20% income tax on any payments you get that are over your £11,500 personal allowance. However, there are still ways you can take advantage of tax relief on this money.
If you have a personal or workplace pension, when you retire you can take 25% of your pension pot as a one-off lump sum without paying any tax on it – and it doesn’t count towards your £11,500 personal allowance.
So, for example, if you are a basic rate taxpayer who has contributed £100,000 into your pension pot, you will have received £25,000 tax relief, leaving you with a £125,000 pot.
Once you retire, you can then take £31,250 of that pension pot as a tax free lump sum!
As a basic rate tax payer, the remainders of the pot would be taxed at 20% as and when you take it out. So, if you are thinking of taking any portion of your pension as a lump sum, or a few big payments, it’s always worth taking advice to make sure that you are doing it in the most tax efficient way as you could end up paying more tax than you have to.
Saving with an ISA
An ISA or ‘Individual Savings Account’, is a way to save or invest that is tax free. There are two main types of ISA: Cash ISAs and Stocks and Shares ISAs.
A Cash ISA is essentially the same as putting your money in a bank or building society account, except that any interest earned is protected from the taxman.
A Stocks and Shares ISA, like the one offered by OpenMoney, means your money is invested in assets such as shares in companies and investment funds. Any income or capital gains from investments, including dividends, is sheltered from the taxman. The potential returns from a Stocks and Shares ISA can be much higher than with cash ISAs – research by Moneyfacts found that the average return during 2017 was 11.75%, compared to the 2.15% that the best cash ISA currently pays.
You can pay money into one of each kind of ISA each tax year, up to a total £20,000. The tax year runs from 6th April to 5th April the following year. So, if you haven’t already, you could still use this year’s ISA allowance.
A big benefit of ISAs is that they offer tax breaks but are still very flexible and usually don’t tie your money up for long periods of time. You can switch providers at any time and you can transfer your money from one type of ISA to another, all without losing any tax benefits.
But bear in mind that often, when trying to achieve higher returns you may end up taking more risk, and the value of a stocks and shares ISA could go down as well as up.
If you’re thinking about using this year’s ISA allowance before it’s too late, our online financial advice platform assesses your appetite for risk and capacity for loss to help work out what kind of investment will suit your circumstances best.
You can also book a free appointment with one of our Financial Advisers who are always on hand to help.
Whether you’re making the most of free money through saving or investing, planning for the future shouldn’t be too taxing!