We have finally heard the proposed changes for the new financial year from the chancellor. One of the big talking points was to do with personal pension allowance.
The big driver for this decision is the fact that many professionals retire early. As they are reach the tax free limit to their pension pots – there is less incentive for them to stay in the job.
The thinking here is simple – remove the limits and people might stay in their jobs longer to accumulate more money. This is the basic principle of greed most people have. This would help the economy with the professionals that we are currently so desperately short of.
Below I will give a summary of the way the personal pensions work. There is a lot of cash each one of us is able to unlock. This require us to maximise the investments we make into our personal pension each year.
I will also review the changes currently proposed for the next financial year. The changes here are really large and will potentially give a massive opportunity to some more fortunate individuals. The main issue and concern here – the changes proposed will benefit only the some.
what is personal pension relief
People have long been incentivised to save for their retirement themselves. In the UK the state pension won’t stretch that far and will only at best allow you to have a modest lifestyle. With the government not being able to support more – hence the pension should be taken care of by the individuals themselves.
One way the government achieves this – giving people a top up to whatever goes into their pension pot. The top up is always equal to the amount you would otherwise pay in tax.
As a result – the higher the tax bracket you are in, the more of an incentive the government is offering you. Those in the basic tax bracket will get only 20%. This however can go all the way up to 45% depending on your personal income level.
how to apply for a pension relief
There are 2 types of pensions that fall under the pension relief rule. One is called a SIPP – often set by your employer for you. The other option is a personal pension you open for yourself and invest into when you can. Personal pension is often taken care off my professional investors while you are fully in charge of your SIPP.
Firstly, let’s start by looking into the more simple of the two – SIPP. For those working for a company you might be aware of the pension incentive plans. Company might offer to match some or all of the pension you are putting away. There are companies that actually pay more than the individual contributes themselves.
SIPP is always an option that people will be able to see in their payslips. The approach to tax here is simple – your contributions are deducted before any tax is applied. This way the government gives you the bonus by not taking the tax away from you.
One additional benefit to keep in mind here – you will end up paying less tax due to the fact that your taxable income becomes smaller than it otherwise would be.
Secondly, the personal pension account that you open for yourself. You can apply for your provider to be receiving automatically the 20% basic tax relief on the amounts you invest. This will be an automated process just by simply submitting a consent form to them.
Those of you who are in higher tax brackets – you will need to submit a Self Assessment tax return form. The money will then be transferred to your personal pension institution.
annual personal pension allowance
So now let’s look into the changes that have been proposed. Previously, you were able to transfer up to £40,000 per year into your pension and claim tax relief on this figure.
For majority this will seem massive and unachievable. So the fact that this has been increased will make many people question if this was simply done to help the rich get even richer.
The current proposal increases this figure by further 50%. This makes the new annual pension deposit allowance £60,000.
This in my personal view will only benefit those at the top already. The logic here – try and incentivise the specialist like doctors, lawyers at the peak of their career to work longer.
I am not sure this is a big enough incentive and will do much of a difference.
lifetime pension allowance
This change however in my personal view is a lot more important and meaningful to many. This point talks about the total value of the pot that a person can accumulate before he or she is required to pay tax on it.
Currently this figure stands at £1,073,100. Yes, that not a type. I am talking about a current allowance of over a million pounds.
Firstly, the current proposal get’s rid of the total amount your pension pot can grow to. This is amazing news and a great incentive for many.
While many people will say that this is out of reach – I will disagree on this point. This will all depend on how dedicated you wish to be about this figure.
Thanks to the time you have to contribute and the benefit that the compounding brings to the table – £1m is a fairly achievable figure. If you are planning to stay in workforce for 40 years – you are required to contribute only £200 per month.
If you get some tailwind and average 10% annual returns over the next 40 years – your total pension will be equal to nearly £1.3m. Without the change – you would be required to pay tax on your life long savings.
summary
On the surface of it the lifelong allowance change can have a real positive impact on many individuals. My main concern here however – if this was so easy to change now why wouldn’t the next government be able to simply reverse this decision.
No matter what the rules around pensions are – make sure to look after your retirement as if there is no state funded pension. Take it as an additional bonus if anything lands in your bank account.
It is worth starting to plan your retirement from your younger days and not leaving it till too late. Make sure you understand what type of lifestyle you wish and how much this will cost you. Work towards achieving this so you can enjoy your life rather than try getting the ends to meet
A further tool I would recommend using in your retirement planning – the tax free benefits that ISAs offer. These accounts can turn your life into a dream.