Tax year end retirement tips and traps savers need to know

“The end of the tax year is a natural time for people to check they are making use of their annual tax allowances before they expire on 5 April and they shouldn’t forget their pension when doing this,” says Tom Selby, Head of Retirement Policy at AJ Bell.

With the cost of living on the rise, saving for the long-term might feel like a luxury people simply cannot afford. However, it’s important to remember the earlier and more often you save, the easier the journey to a decent retirement will be.

For those who can keep squirreling money away, it’s crucial to make the most of the tax breaks available – as well as being aware of potential pitfalls and bear traps.

Five ways pensions can boost your retirement…

1. Upfront savings boost Part 1: Pension tax relief

Pensions benefit from upfront tax relief, providing an immediate boost to the value of your fund. This is granted automatically at 20% of the amount going into your pension (which is the equivalent of a 25% boost to your contribution), while higher-rate taxpayers can claim back an extra 20% and additional rate taxpayers 25%.

So if you pay £80 into a SIPP, that will be topped up to £100 regardless of how much income tax you pay. A higher-rate taxpayer could then claim back £20, while an additional-rate taxpayer could claim £25. In effect, getting £100 in a pension can cost as little as £55.

You can’t pay in more than your taxable UK earnings overall, but anyone with spare cash should consider making a contribution before the tax year ends on 5 April in order to take advantage of unused tax relief for 2021/22.

2. Upfront savings boost Part 2: Your FREE 100% savings boost!

If you're a member of a workplace pension scheme your employer will pay in the equivalent of 3% of your salary provided you pay 5% – so effectively free money from your employer towards your pension fund.

Furthermore, of the 5% you pay yourself, 1% normally comes from tax relief, so you actually only pay 4% but you get an overall contribution of 8%.

The combination of upfront tax relief, tax-free investment growth and 25% tax-free cash from age 55 is extremely attractive for those who can contribute to a pension, while for most people staying in a workplace pension remains a no-brainer.

3. Carry forward to super-charge your annual allowance

The amount you can save in a pension each year has been eroded from a high of £255,000 in 2010/11 to £40,000 today. This is still double the ISA allowance, and there is a tax trick you can use to boost it even further.

Pensions ‘carry’ forward’ rules allow you to use unused allowances from up to the three prior tax years in the current tax year (provided you have allowances available and were a member of a pension scheme in the tax year you are carrying forward from).

So if you didn’t pay anything into a pension in the 2018/19, 2019/20 or 2020/21 tax years, you could carry forward £120,000 of unused allowances and add them to this year’s £40,000 allowance.

As mentioned above, it’s worth noting the amount you can personally contribute to a pension remains limited to 100% of your earnings during the tax year. However, employer contributions aren’t limited in the same way. Therefore, carry forward can be particularly useful for business owners or anyone who is trying to make up for lost time saving for retirement.

4. Pay profits into a pension and slash your tax bill

If you’re self-employed then paying your profits into a pension is a great way to lower your tax bill. Take the example of a higher-rate taxpayer who owns a company and expects to turn a profit of £20,000 in the 2021/22 tax year.

If they are able to pay the entire £20,000 profit from the company directly into a pension as an employer contribution, the company shouldn’t have to pay any tax or employer National Insurance on the contribution. The money will be able to grow tax-free, with tax only coming into play when you come to make a withdrawal from age 55.

In comparison, if they were to take the profit as salary (assuming the entire £20,000 remains in the higher-rate tax band), they will have to pay at least £400 in employee National Insurance and £8,000 in income tax. In addition, the business will have to pay employer National Insurance at 13.8% (£2,760).

And if they decided to take the £20,000 profit as a dividend, corporation tax will first be levied at 19%, reducing the payment to £16,200. They would then pay a tax of 32.5% on the dividend above £2,000 (the dividend allowance), meaning they would end up receiving £11,585 after tax.

5. Using pensions to reduce IHT

While for most people the main purpose of a pension is to provide an income through retirement, reforms introduced in April 2015 mean pensions are now extremely tax-efficient on death.

If you die before age 75, your pension beneficiaries won’t pay income tax on the funds when they receive them (either as a lump sum or into a pension in their own name). If you die after age 75, your beneficiaries will pay income tax on the funds, but they will be able to use their own personal tax-free allowances (£12,570 in 2021/22) – particularly useful for children and grandchildren who might have no other income.

If any of your beneficiaries receive the funds into a pension, they too can nominate their own beneficiaries, meaning the funds can be passed on again.

Pensions are also free from inheritance tax (IHT) in most circumstances. As such, pensions now provide a way of passing money down the generations, with the taxman potentially not seeing a penny of it.

…and three bear traps to watch out for

1. Beware the 90% pensions allowance cut

Hundreds of thousands of savers have flexibility accessed their retirement pot each year since the pension freedoms launched in April 2015. And with the cost-of-living set to continue spiralling throughout 2022, it is likely more over 55s will need to turn to their pension to plug a short-term income gap.

However, anyone who makes a flexible withdrawal from their retirement pot for the first time triggers the ‘money purchase annual allowance’ (MPAA), permanently slashing their annual allowance from £40,000 to just £4,000. The Treasury also kicks savers while they are down by removing the ability to carry forward any unused allowances from previous tax years.

The Government introduced this measure to stop people recycling large sums of money through pensions to benefit from extra tax-free cash.

People planning to access their pension flexibly, either this tax year or next, need to think carefully about the impact it will have on their ability to save in the future.

Anyone wanting to access their pension but concerned about triggering the MPAA should consider whether just taking their tax-free cash could be sufficient, particularly where they are planning a one-off purchase rather than taking a regular income.

It is also possible to access up to three pension pots worth £10,000 or less without triggering the MPAA, provided each pot is extinguished in its entirety.

2. Emergency tax on flexible withdrawals: How to get your money back in 30 days

The first flexible payment you take from your pension will be taxed on an emergency basis by HMRC.

This means the Revenue assumes you are making 12 withdrawals rather than just the one, with the upshot being you are likely to be significantly overtaxed – potentially by thousands of pounds.

If you want to get this money back you can do it through your self-assessment tax return, or by filling out one of three forms:

• P50Z – if the payment used up your pension pot and you have no other income in the tax year
• P53Z – if the payment used up your pension pot and you have other taxable income
• P55 – if you have withdrawn only part of your pot and you’re not taking regular payments

HMRC says this should get sorted within 30 days provided the correct form is completed. At the last count £835 million had been reclaimed by savers who had filled out these forms.

3. Keeping your death benefit nominations up-to-date

Because pension death benefits are now extremely tax-efficient it is even more important savers wanting to bequeath money to loved ones keep their nominations up-to-date.

Changes in life circumstances such as the birth of a child, marriage or divorce could affect who you want to receive your pension if you die, so the tax year-end provides a useful opportunity to review and revise your death benefit nominations.