Higher rate tax relief on pension contributions could be curtailed or even scrapped within the next two weeks.For 40pc and 45pc taxpayers the consequences will be significant and will require millions of people to rethink their retirement investment strategies. But the more pressing question is what to do ahead of the 16th March budget announcements.
Pension providers are already seeing a surge in contributions ahead of the budget as higher rate tax payers are taking advantage of the tax boost whilst it still exists.
If you are a higher rate taxpayer, investing £6,000 now will attract a 40pc tax relief boosting the total contribution to £10,000 – an effective 67% increase. If you are an additional rate tax payer you only need to pay £5,500 to achieve the same £10,000 overall contribution – an effective 82% increase on your investment as a consequence of the 45% relief currently available.
If, as is widely expected, the tax reliefs are curtailed making an additional investment in your pension before the 16th March could have a significant impact in the longer term. Consider this….
- A £10,000 initial investment with no tax relief would grow into a £27,126 pot over 20 years at a compounded annual return of 5pc.
- By comparison, a £10,000 contribution made by a higher-rate taxpayer and attracting 40pc tax relief would turn into a £45,209 pot over the same period, given the same investment returns.
So what do you need to do?
- If you belong to a company pension scheme find out if it’s possible to make further contributions within the next two weeks.
- If you have a SIPP your provider will claim the basic rate tax relief direct from HMRC and add it to your account. For Higher-rate and additional-rate taxpayers you need to claim the further 20pc and 25pc relief via your annual returns. Any money you pay in between now and the 16th March will need to be entered on the tax return for the year ending 5th April 2016 for which the filing deadline is 31st January 2017.
To get the maximum benefit from tax-relief you need to invest in your pension when you are at the high-earning stage of your career. If you contribute as a 40% taxpayer today, under current rules you could draw on your pension pot when your earnings are lower – for example after you retire – and, depending on your earnings at that time, only pay 20% tax. You can also make the most of your tax-free element of your pension – the 25pc that does not attract tax.
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