Tax
Tax relief on pension contributions
For personal pensions, you will pay income tax on your earnings before any pension contribution. However, when you pay into your pension, the pension provider will claim back tax from the government at the basic rate of 20%. So this effectively means that for every £80 you pay into your pension, your total contribution will be £100.
If you are a higher rate (40%) taxpayer, you can claim the difference through your tax return or by contacting HM Revenue & Customs (HMRC) and if you're an additional rate taxpayer (50%) you can claim the difference through your tax return.
For occupational or public service pension schemes, your employer usually takes the pension contributions from your pay before deducting tax (but not National Insurance contributions) and you only pay tax on the remainder of your pay.
This means that no matter what category of taxpayer you fall into, you will benefit from the full tax relief immediately.
That said, you should be aware that some employers will use the same method as that for personal pension schemes.
A change in rules
On 6 April 2006 (A-Day), a new set of pension rules came into effect. The previous eight separate sets of rules were replaced by one simple set of regulations which apply to all types of pension.
The new rules have meant that you can now contribute and receive tax relief on up to 100% of your earnings each tax year, subject to your annual limit (currently £50,000).
However, the rules have also seen the introduction of a cap on the total amount you can put into your pension over your lifetime. The limit is currently £1.8 million but will be lowered to £1.5 million in April 2012.
Pension savings above this limit will be subject to tax at 55% for a lump sum or 25% if taken as a pension.
Tax-free cash
The earliest you can get your hands on your pension fund is when you reach the age of 55.
Thanks to the A-Day rule changes , you can now take up to 25% of your total pension savings as a tax-free lump sum when you retire. However, the lump sum is only tax-free if it is less than 25% of the lifetime allowance for that tax year.
If your total pension savings are greater than the lifetime allowance, you can take the excess as a cash lump sum but you will have to pay a 55% tax charge.
Once you have taken your tax-free lump sum, you can then either use the remaining money to buy an annuity or you can draw a taxable income directly from your pension fund – known as a drawdown pension
In certain circumstances, you can also take your whole pension savings as a cash lump sum and still benefit from the 25% tax-free status. However, your total pension savings must be £18,000 or less for the 2011-12 tax year.
Bear in mind that pension schemes vary so check with your provider to find out what your particular scheme allows.
