Understanding Tax On Your Pension

Preparing for retirement can be a complex process, and many of us don’t appreciate how important it is to have a plan in place early on. Pensions are an important tool for building your savings, and one of the key considerations when growing your pot comes from managing your pension in a tax-efficient way. The way you contribute to and withdraw from your pension can significantly impact how much tax you pay. In this article, we’ll explore the relationship between pensions and taxes.

Remember that everyone’s personal financial circumstances are different and this article does not constitute advice. Speak to an expert on how to manage your retirement fund and maximise tax efficiencies in a way that is suitable for you.

Before diving deeper into pension strategies, it’s helpful to define some key terms:

• Contributions: Payments made into a pension plan, which can come from multiple sources, including the employee, employer, and the Government.
• Growth: The increase in the value of a pension over time. Growth can occur through continued contributions, asset appreciation, and investment performance.
• Withdrawals: The methods by which you can take money out of your pension, including drawdowns, lump sum payments, and annuities.
• Tax-free cash: Many pension schemes allow you to withdraw up to 25% of your pension pot as a tax-free lump sum.

Tax-efficient saving

One of the key benefits of pensions is their tax efficiency. When you contribute to a pension, you benefit from pension tax relief, which means that part of the money that would have otherwise gone to the Government as tax instead goes into your pension. This tax relief can help reduce your overall tax liability and, over time, can substantially boost your retirement savings.

Different types of pensions come with various tax rules. For instance, workplace pensions typically involve employer contributions, and you might also be entitled to Government contributions, depending on the type of pension. This makes pensions a powerful tool for long-term, tax-efficient saving.

How your pension income is taxed

Once you begin drawing on your pension, it's important to understand how your pension income is taxed. The key to this is your Personal Allowance, which is the amount of income you can earn each year without having to pay tax. For the 2024/2025 tax year, the Personal Allowance stands at £12,570, but it can vary depending on personal circumstances.

Your Personal Allowance is made up of several types of income, including:

• Earnings from employment
• Any taxable benefits you are entitled to
• Private pensions (though up to 25% can be taken tax-free)
• The State Pension and any Additional State Pension entitlement
• Other income, such as savings and investments

If your total income from these sources exceeds your Personal Allowance, the excess will be subject to tax. It’s also worth noting that tax rules can change, so it’s always important to stay informed and seek advice from experts to make sure you're managing your pension in the most tax-efficient way possible.

Our experts can help you navigate tax and pensions

Planning for retirement can be daunting, especially when it comes to understanding the tax implications of your pension. However, expert advice can ensure that your pension works as hard for you as possible, helping you to maximise your income in retirement while minimising your tax liabilities.

Ryan Milne, an adviser from M&G Wealth advice stresses the importance of getting tax planning right;

“We know that planning for retirement can be an overwhelming experience. Tax on pensions is also a difficult world to navigate, but with the right advice, you can get your pension pot working harder for you, giving you peace of mind in the long-term. Every day, we work with clients who benefit from our advice that helps them grow their retirement savings in a tax-efficient way.”

At M&G, our experienced advisers are on hand to help you navigate the complexities of pension planning and tax. Whether you’re just starting to save for retirement or approaching the time to draw down your pension, our team offer people tailored advice every day to ensure they can make the right decisions for the future.

If you’re interested in learning more about how our team can support your own retirement planning, get in touch today and discover the full value of financial advice.