Pensions and alternative investment vehicles for retirement

Pension contributions 

When contributing to a personal pension (other than salary sacrifice), Income Tax relief is available at an individual’s marginal rate. For higher earners this could be 40% or 45% and in certain circumstances, up to 60%.

There’s no limit on the amount that an individual can contribute to a registered pension scheme and, if you’re a UK resident aged under 75, you may receive tax relief on your contributions. However, this relief is limited to relief on contributions up to the higher of 

• 100% of your UK taxable earnings; or
• £3,600.

Additionally, the annual allowance (the maximum amount of contribution entitled to tax relief in a tax year) was increased for the 2023/34 tax year to £60,000 (previously £40,000), allowing individuals to contribute up to this amount, receiving tax relief at their marginal rate where earnings support this. As an example, an additional rate taxpayer (45%) utilising their full annual allowance, can expect to receive £27,000 tax relief on a contribution of £60,000, and therefore the full contribution is only costing them £33,000. This is attractive for many, particularly those paying higher or additional rate tax on earnings, as it allows them to save significant sums tax efficiently.

‘Carry-forward’ creates a further opportunity, allowing you to use any unused annual allowance from the three previous tax years, as long as you were a member of a registered pension scheme in those years. For example, unused allowances for 2022/23, 2021/22 and 2020/21 can be utilised, however, any unused allowance for 2020/21 will be lost if it is not utilised this tax year.

Some restrictions do remain, particularly for high earners. A minimum reduced (or tapered) annual allowance remains in place at £10,000 (increased from £4,000) for those with earnings and/or income above the adjusted income limit, currently £260,000. Where this applies, the annual allowance is reduced by £1 for every £2 of earnings above this limit, until the reduced annual allowance is £10,000. An individual with adjusted income of £360,000 or above would have their annual allowance fully reduced to £10,000, restricting the contribution amount receiving tax-relief. An example of this is shown below:

A major change in the Spring Budget 2023 was to abolish the lifetime allowance (the total amount that can be accrued within pensions in a lifetime – currently £1,073,100). This has further increased the attractiveness of maximising pension contributions, albeit with the threat of a new government reinstating this tax. However, restarting contributions may not benefit all, and therefore professional advice is recommended.

In this insight we shared how a tax-efficient income can be created in retirement using a number of sources, with pensions being an important one, along with the other alternatives we’ve listed below. Using the above example of a contribution of £60,000, this would cost an additional rate taxpayer £33,000. Under current rules, 25% of the value of a pension can be taken tax-free (£15,000 of this amount) and the remainder withdrawn at your marginal rate. 

Where individuals have a number of sources of income in retirement, it may be that, if structured correctly, income from a pension will fall into the basic rate tax band despite receiving relief at a higher rate on the original contribution. Therefore, the additional £45,000 in this example might be taxed at 20% (£9,000 tax) and net income of £36,000 withdrawn, leading to £51,000 net income from a £33,000 net contribution. This, of course, doesn’t consider the additional benefit of tax-free investment returns within the pension wrapper and, alongside a sensible investment strategy, this can enhance the above benefit further.