Top-rate payer? You can save 60.8pc
If you use salary sacrifice, your employer might decide to pass on the savings it makes in National Insurance to you via your pension.
Additional rate taxpayers would save 45pc in tax, plus 2pc in National Insurance. If the employer passes on its own 13.8pc in National Insurance, this can really add up.
Marco Malagoni, of investment managers Waverton, said: “Sacrificing some of your salary or bonus into a pension is undoubtedly the most effective way of boosting your retirement pot, especially if your employer adds their National Insurance savings. An additional-rate taxpayer can benefit from as much as 60.8pc tax relief, so it can make a huge difference.”
For someone earning £150,000, he added that if they received a £20,000 bonus, they could make huge savings by asking their employer to pay it straight into their pension.
“They would instantly save 45pc in income tax, which is £9,000, plus their 2pc employee’s National Insurance of £400. If the employer also passed on its own 13.8pc National Insurance saving, the gross contribution of £20,000 would be topped-up by £2,760. So the total amount of tax relief gained would be £12,160, or 60.8pc.
“This means instead of taking home £10,600, they could add £22,760 to their pension.”
Again, you just need to speak to your employer to arrange this.
Dodge the 60pc tax trap
Under tax rules, you lose £1 of your personal allowance for every £2 earned over £100,000. This means that by the time you earn £125,140, the top-rate threshold, you have no allowance left. Not only that, you are taxed at 40pc on the extra amount that becomes taxable too.
So if you earn £105,000, you’ll pay 40pc on £5,000, or £2,000. You’ll also pay 40pc on the £2,500 you lost from your personal allowance, which is another £1,000. Suddenly, that £5,000 has cost you £3,000 in tax – or 60pc. But there’s a way around it.
Ms Moffat said: “The lack of threshold changes in the recent Budget mean the rate of tax for those earning between £100,000 and £125,140 can be 60pc or more.
“Someone earning £125,140 could pay a pension contribution of £20,112, which will increase to £25,140 with basic-rate tax relief. That reduces their ‘adjusted net income’ to £100,000, which will give them back their personal allowance and mean they escape the 60pc tax trap.
“As this person will still be a higher-rate taxpayer, they can claim a further £5,028 higher-rate tax relief from HMRC. In effect, the £25,140 pension contribution has only cost them £15,084.”
Mr Malagoni added: “Sacrificing salary or a bonus would be even more tax efficient if it helps reclaim the personal income tax allowance of £12,570. For someone earning a basic salary of £100,000, if they received a bonus of £20,000 they could save 60pc of it in income tax, or £12,000, by putting it straight into their pension.
“Adding the 2pc employee’s and 13.8pc employer’s National Insurance savings brings the total tax relief to 75.8pc.”
“Rather than only taking home £7,600, they could get £22,760 into their pension.”
You can make pension contributions through your salary, or you can make a one-off payment straight to your provider. However, remember that money is generally locked away until retirement. The minimum retirement age is currently 55 and will increase to 57 in April 2028. If you access the money earlier than that you will pay ruinous tax charges.
How to make a lump sum contribution
You might find yourself in a situation where regular salary sacrifice doesn’t work for you. For example, you could be self-employed or your employer simply doesn’t offer it.
Or your income might fluctuate and stuffing your pension with cash at the start of the tax year, which you then can’t touch until you reach retirement age, might be something you’re not willing to do. You might even get to March, the end of the tax year, and realise you have more money than you thought, so are looking to save some tax by boosting your retirement pot.
In these scenarios, a lump sum contribution might be a good option.
Nick Nesbitt, from financial planning firm Mazars, said: “The way this works is that you work out the gross contribution that is required to achieve a certain tax outcome. You then pay 80pc of that amount as a net contribution into your pension.
“It will usually take the form of a payment to the pension provider’s bank account, with a specific reference number, or a payment via an online portal. It’s usually pretty straightforward.
“The pension administrator will automatically credit the 20pc tax relief. You then enter the gross contribution amount on your tax return and receive any higher or additional rate tax relief as a tax rebate, or a reduction in tax due.”
For example, if you earn £60,000 you may want to reduce your income to the lower tax bracket of £50,270. To do this, your gross contribution would need to be £9,730, but given 20pc is provided in tax relief, you only need to pay in £7,784 yourself.
As a higher-rate, 40pc, taxpayer, you’ll get an extra £1,946 on top of that, meaning effectively you’ve only paid £5,838 for a pension contribution of £9,730.
However, there are some things to be wary of when employing this strategy.
Mr Nesbitt added: “You can’t contribute more than your earned income in that tax year. You are also restricted to the annual allowance which is currently £60,000 a year with an ability to carry forward unused allowances from any of the last three tax years.
“Pensions are typically invested, so there is generally an element of investment risk with making such contributions.”
Beware the annual allowance ‘taper’ that hits high earners
Since April 2023, you’ve been able to pay the most of £60,000 or your annual salary into your pension and get tax relief. If you earned £110,000 for instance, you could reduce your income by £60,000 through pension contributions – and earn 40pc in tax relief on the full amount. This would also take you down a tax bracket.
However, under the annual allowance “taper” high earners will lose £1 of this allowance for every £2 they earn over £260,000. Once you have an income of £360,000, your annual allowance will have fallen to £10,000. Making pension contributions beyond this amount will not qualify for tax relief.
You can take advantage of any unused allowance from the previous three tax years.
Don’t forget to claim back your tax relief
As explained above, some pension providers operate under a “net pay” arrangement while others use “relief at source”.
If your employer or personal pension provider runs a relief at source scheme, and many do, tax relief is claimed for you – but only at the basic-rate, 20pc, rate so higher earners could be missing out.