Eight reasons to top up your pension by April

There’s no doubt that pensions are one of the most tax-efficient ways to save for the long term. It’s also a very effective means of reducing your tax bill, particularly if you pay more than basic-rate tax.

Below, we take a look at some of the ways that putting additional cash into your pension before the end of the tax year could boost your finances.

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It’s worth bearing in mind that one key attraction of pensions – the fact that they can be passed down the generations free of inheritance tax (IHT) – is set to be removed from April 2027.

As a consequence, says Ben Yearsley, investment consultant at Fairview Investing: “It may well make more sense to draw from your pension in the future, rather than keeping it intact [to pass on].”

However, the end of that benefit does not detract from the other positives attached to optimising your contributions to a pension.

1) A boost for your long-term savings pot

At the most fundamental level, your pension is your retirement fund – so every payment you make into it and each chunk of tax relief you receive (see point 2) is another step towards financial security in retirement.

Moreover, the longer you have until you’re likely to need a retirement income, the more chance your money has to grow and compound returns. Compounding takes place when investment earnings, whether capital growth or dividend income, are reinvested and themselves produce growth or income, which in turn produces more reinvested returns, and so on.

As the decades pass, compounding has an increasingly significant effect. As a stark example, if you invested a lump sum of £10,000 at 5% a year but withdrew the growth each year, then you would have earned £5,000 of growth after 10 years and £20,000 after 40 years - a total of £30,000 including the original capital.

In contrast, if you left the growth invested to compound each year, then after 10 years you’d have a total of £16,470, and after 40 years it would be worth a meaty £73,584 – almost 2.5 times the £30,000 value without compounding at work.

Clearly, the more you add to your invested capital over that time, the better placed you are for the compounding effect to work its magic.

2) Full tax relief

Contributions into a pension receive tax relief at your marginal (highest) rate. So if you’re a basic-rate taxpayer, for every £80 you put in, the government adds £20 to make it up to £100.

“Higher and additional-rate taxpayers can claim even more (an additional 20% and 25% respectively) through their tax returns, reducing their effective tax rate and making pension contributions particularly attractive for those earning above the basic-rate threshold,” explains David Gibb, a chartered financial planner at Quilter Cheviot.

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Even adult non-taxpayers and children stand to gain in this respect, with payments of up to £2,880 a year receiving the 20% top-up to bring them up to £3,600. That may not be a large sum, but as Yearsley observes, “it’s still a free £720”.

You can pay in up to £60,000 in a tax year (or the value of your annual earnings if that is lower); but if you’re in a position to contribute more, you can also make use of any unused pension allowance from the past three years. 

3) Employer contributions

Auto-enrolment workplace pension schemes require a minimum total contribution for employees of 8% of their earnings, of which the employer is obliged to contribute 3%. However, many organisations are considerably more generous.

As Gibb observes: “Many employers offer pension contribution matching, meaning that additional contributions by the employee could unlock extra employer payments, further enhancing the value of a pension.”

Again, that’s grist to the mill as far as the compounding effect is concerned.

4) Avoidance of higher-rate tax bracket

There may be more immediate benefits to additional pension contributions too, if your earnings are potentially in danger of tipping you over a key tax threshold.

If your income is more than £50,270, you’ll find yourself paying 40% tax on earnings above that threshold. An extra payment into your pension effectively reduces your income for tax purposes, and therefore could help you to avoid paying a higher tax rate on any earnings.

“As millions of people are drawn into higher income tax bands and paying more tax as their earnings rise, increasing pension contributions is one of the few ways to mitigate against this,” explains Gary Smith, partner in financial planning at wealth manager Evelyn Partners.

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5) Retaining full Child Benefit

An equally significant threshold for many families occurs at £60,000. Parents receiving child benefit start to be penalised by what’s known as the High-Income Child Benefit Charge once either parent individually earns above this level, with child benefit gradually clawed back in additional tax until it is lost entirely once their income tips above £80,000.

“Pension contributions reduce your taxable income, which means that if your earnings are above £60,000, making contributions could bring your adjusted income down and allow you to keep more of your child benefit rather than losing it to the charge,” Gibb explains.

6) Retaining the full personal allowance

A higher tax threshold is equally significant for 40% taxpayers who are in danger of earning more than £100,000.

In this situation, adds Gibb, “additional pension contributions can mitigate the loss of the personal allowance, which starts to be withdrawn once income exceeds £100,000. For every £2 earned over this threshold, £1 of the personal allowance is lost, leading to an effective 60% tax rate for many earners.”

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The impact of that punitive tax rate may be exacerbated by the loss of the tax-free childcare benefit, which is withdrawn when either parent earns more than £100,000.

By contributing to a pension, you can bring your taxable income back below the threshold, reinstating your personal allowance and thereby significantly reducing your tax liability; and potentially also ensuring continuing payments towards childcare costs.

7) Reduce national insurance through salary sacrifice

Smith makes the point that a particularly tax-efficient way to channel extra earnings into your pension pot is via salary sacrifice. Under this scheme, you agree to a reduced salary, and in return your employer pays the sacrificed sum into your pension.

Not only is your income tax bill reduced as a consequence, but both you and your employer also benefit from lower national insurance (NI) contributions. In some cases, he adds, salary sacrifice “can additionally draw in an extra pension contribution from the employer due to its NI saving”.

8) Take money out of your business

If you own your own business, says Yearsley, then making pension contributions from your company to your pension is “one of the most tax-efficient ways to get money out of the company”.

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You’ll pay no income tax or dividend tax on the contributions; NI bills for both parties will be smaller; and because contributions are treated as an “allowable expense” taken from taxable profits, they can be offset against the company’s corporation tax bill.

The bottom line is that boosting payments into your pension each tax year is one of the most efficient ways not just to build a larger retirement fund, but to minimise your tax bill and potentially to retain valuable benefits that you might otherwise have lost as your income rose. What’s not to like?