When cash back comes your way its music to most people’s ears. With your pension the cash back comes in the form of tax relief. In other words, the government hands you back the income tax you might normally pay on money you put into your savings. That’s free money right there!
Tax relief is the belting chorus on the best power ballad. The extra cash gives your pension payments a major boost. And, that makes your pension one of the best ways to save for your retirement.
How does tax relief work?
It’s a pretty simple concept. Whenever you pay into your pension, normally monthly, or with an occasional lump sum you are given back the income tax you have paid on this money. That tax cash back goes into your pension on top of your payment. So, in effect your payment is made before tax. Happy days!
The amount of tax relief that gets added to your pension payment depends on how much you earn, and the rate of income tax you pay. You could pay income tax as a basic rate (20%), higher rate (40%) or additional rate (45%) tax payer. Here’s a couple of examples:
Personal pension example
Personal pensions are a type of defined contribution pension in which you build up a pot of money for retirement. The income you get depends on how much is paid in, how well the investments grow your savings and what charges are made on your pension by your provider.
Sally has an annual salary of £20,000 and is a basic rate 20% tax payer. She joins her employer’s workplace personal pension scheme. Sally’s payslip shows her monthly pension contribution is £80.00. The cash she gets back as tax relief is as follows:
Sally’s pension payment: £80.00
Basic rate tax relief 20%: £20.00
Total paid into her pension: £100.00
Final salary schemes
If you are a member of a final salary pension scheme you get the same amount of tax relief as in the example shown above for personal pensions. The difference is that you own a promise from your employer to pay you a certain income for life when you retire. Your income depends on how many years you work for your employer and the salary you earn.
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