Why do you need a pension?
How pensions work
You make contributions to an insurance company to help fund your retirement. The insurance company invests these contributions in a range of different investments to build up a sum of money over time. This sum then provides a retirement income later in life.
How tax relief works
If you wanted to invest £100 in your plan, you need only contribute £80 and the taxman will contribute the other £20.
The Government wants to encourage people to save for their retirement. For that reason, it has made pension plans more attractive. One way it does this is through tax benefits:
- Any contributions you make to a pension receive basic rate tax relief, even if you don't pay tax. For every £1 you invest, the taxman puts in another 25 pence.
- If you pay higher rate income tax, you can reclaim extra tax relief through your self-assessment form.
- Once invested, your savings grow virtually free of tax.
- If you die before taking your retirement benefits, your husband, wife, civil partner or dependants don't normally have to pay tax on any lump sum they receive.
All these tax benefits help you build a better retirement. Tax treatment depends on individual circumstances and may be subject to changes in the future.
A few restrictions
Not surprisingly given such generous allowances, there are some restrictions to ensure that the system isn't abused. For instance, there's a limit on tax relief.
Each year, it's available on contributions you make into a pension up to the greater of £3,600 or one hundred per cent of your earnings (this includes the tax relief).
People with no earnings, such as full-time carers or children, can still pay in £3,600 a year (inclusive of tax relief) or have this amount invested on their behalf. Your employer can also make contributions to an individual pension for you.
There is a tax charge of forty per cent on any contributions, including those made by your employer, above a maximum level each tax year. This is known as the Annual allowance.
The forty per cent charge applies only to the amount in excess of the Annual allowance, not to the full contribution.
Find out more
Your financial adviser will be able to tell you more about the benefits of saving for retirement using a pension plan.