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Like tax, pensions are a notoriously unexciting conversation starter. They’re something we should all know more about, but we just can’t bring ourselves to get clued up. As an employee, your company probably has a private pension scheme that you pay into directly from your salary, so you’ve not given it a second thought.
When you’re freelance though, it’s a different situation. You likely won’t have anyone offering you a private pension to pay into automatically, so you have to arrange it all for yourself. And put money aside to pay in.
Now, as you know, we’re tax people at TaxScouts, and while we can tell you ALL about the tax implications of pensions, we wanted to get some experts in to provide a more in-depth overview. So we got in touch with our trusty partner, Penfold – a one-stop-shop digital private pension platform, perfect for the self-employed. You can track, manage, invest and save your contributions with them – and all from your fingertips.
Penfold helped us put together these six facts that you should know about pensions, to help you take control of your financial future.
This might seem obvious, but let’s start from the very beginning.
A pension is a savings scheme that you can use to financially plan for your future. A private pension, which is also known as a personal pension, is set up by you. You can make monthly, annual, or one-off contributions to it. And these contributions will be invested in your chosen pension fund.
Once you reach 55, you can start withdrawing from your pension – but know that it’s taxable income, like any other money that you earn. Also useful to know is that you can withdraw as a lump sum or in monthly portions like a salary.
As you may know, paying National Insurance makes you eligible to claim certain state provided benefits. That’s why you have to pay it even if you earn less than the tax-free Personal Allowance. The benefits that you can claim with it include the Disability Allowance, access to the NHS, the state pension, and more.
Here’s what you’re left with when you put your savings into the state pension 👇
The full amount to claim is £137.60 per week – and you need 30 years of National Insurance contributions to be eligible to claim this full amount. This is set to rise by 8% from April 2022, although this is yet to be confirmed.
As a sole trader, you get a boost from the government on your private pension contributions. OK, a boost is a bit misleading. What actually happens is that the government returns the Income Tax you’ve paid – so for every £100 you save, they’ll add £25 of your yearly takings are less than £50,270. For every £1,000 you save, that’s £250 – and so on, up until you reach the £40,000 annual limit.
If you earn more than £50,270 a year, the tax relief is bigger still – £40 back for every £100 saved. Check out our Pension Tax Relief Calculator to calculate how much you could claim.
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HMRC will basically give you back the tax that you paid on the income that you used for your pension contribution.
In your case you earned £49,000 and contributed £1,000 to your pension.
You get £250
Your pension provider will automatically get this for you and add it to your pension pot.
Your pension pot will now be worth £1,250.
Right, stay with us here. We’re about to talk about compound interest. The basics are that the longer you save, the more money you can snowball into your pension. When you contribute, you can choose to hold or invest your contributions – and if you choose to invest it, the stocks and bonds could prompt significant growth.
Let’s look at this in terms of the actual figures: if your pension grows, for instance, by the average of between 5-7%, saving £1,000 when you turn 20 could grow to £15,000 by age 60.
(A long wait, sure, but worthwhile.)
If, however, you wait until 30 to save your £1,000, it would grow to just £7,600. If you want to read more about how your pension can be invested, check out Penfold’s handy blog on that topic exactly.
As with all things tax, there’s a limit to take into account when you’re saving into your pension. The annual pension allowance is £40,000, or 100% of your income. Whichever is lower.
This means you can contribute up to £40,000 tax-free. But any contributions that exceed this will mean that your private pension tax relief will be removed.
If you earn more than £240,000 a year, you should be aware of the tapered pension annual allowance which reduces the tax-free allowance you’re eligible to use.
When it comes to withdrawing from your pension, you’ll also have to consider the pension lifetime allowance which, in the 2022/23 tax year, is £1,073,100. The pension lifetime allowance is basically the limit that you’re allowed to withdraw from your pension tax-free over your entire lifetime. (Dramatic, right?)
By tax-efficient, we mean a legitimate financial tool that lets you earn the most money, whilst owing the least in tax. Tax-efficiency is not the same as tax evasion – and it’s important to make this distinction! Here’s why pensions are good for tax-efficiency:
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