Pensions are usually top of the list when it comes to retirement planning due to their generous tax reliefs. However, there are other investments to consider, and it can be advantageous to combine sources for the most efficient income and to utilise all allowances available. 

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.

Alternative investment vehicles 

In order to create a tax-efficient income in retirement, it is important to utilise allowances available, and where an individual has exhausted their pension contributions, there are alternative options to save for retirement outside of pensions. 

Individual Savings Account (ISA)

Individual Savings Accounts (ISAs) are a popular choice to supplement pension savings. Although not offering the attractive tax reliefs that pensions provide, they do allow tax-free growth and the ability to withdraw funds at any point now, and in the future, without tax. An individual can contribute up to £20,000 to an ISA each tax year.

General Investment Account (GIA)

The use of a General Investment Account (GIA) is often overlooked at tax year end as there are no tax reliefs for investing nor do they allow tax-free growth like an ISA. However, they can form another building block for retirement income allowing you to invest in assets that will utilise your annual dividend allowance (£1,000) and allow you to rebase the investments each year utilising your Capital Gains Tax (CGT) allowance (£6,000 in 2023/24 and £3,000 in 2024/25). Savings allowances (for basic and higher rate taxpayers) can also be utilised on interest income. Combining the use of all of these allowances allows a GIA to act like an additional ISA up to a certain amount. Similarly, these allowances can be used to draw a tax efficient income (or capital) in retirement, supplementing income from other sources.

Additionally, it can be tax-efficient to hold certain assets in this type of account, for example UK Government Gilts or qualifying Corporate Bonds. These investments are not taxable to capital gains so it can be attractive to invest in issues where most of the return is expected to be through capital gain.

Venture Capital Trust (VCT)

A lesser-known source of retirement income is Venture Capital Trusts (VCTS) and dividends from these investments are tax-free. You can invest up to £200,000 in a tax year, receive an Income Tax reduction of 30% of the investment amount based on your income tax liability for the year, and the subsequent disposal of your VCT is potentially exempt from CGT, subject to various conditions being met. A VCT has set rules on what it can be invested in and generally these are high-risk start-up companies. As such, VCT’s are therefore not suitable for all, but they can be an important vehicle as part of an overall portfolio of assets.

How we can help

We have shared a number of vehicles to build a retirement pot tax efficiently and, it is often beneficial to utilise a number of these options alongside each other. Our experts can help you to set a strategy early to ensure your retirement pot makes use of these allowances each year, grows efficiently and allows you to take an income in the most optimal way. Alongside this, we can advise you on a sensible, low-cost, risk appropriate investment strategy, which allows you to meet your retirement objectives.

Buzzacott Financial Planning is authorised and regulated by the Financial Conduct Authority. This article has been prepared to keep readers abreast of current developments. Professional advice should be taken in light of your circumstances before any action is taken or refrained from. The value of investments, and the income from them, may go down as well as up and investors may not get back the amount originally invested.

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