Using your pension is still one of the best ways to save up to 73% tax

“If you can afford it thenincreasing your pension payments is a great life hack and one of the best ways to reduce your personal tax burden”

With the Budget only days away, data from interactive investor shines a light on the rising tax burden as well as showing how pension savers could save up to 73% tax by using their pension.

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Pension contributions are free from income tax and can also save national insurance if pension savers use salary sacrifice. In addition, pension contributions can impact the amount of child benefit higher-rate taxpayers receive and significantly reduce their tax burden.

• Pension contributions allow basic-rate taxpayers to save 20% income tax and an additional 10% national insurance if they make pension contributions through salary sacrifice. Using salary sacrifice means it costs only £70 to pay £100 into your pension
• Pension contributions save higher-rate taxpayers 40% and an additional 2% national insurance if they make pension contributions through salary sacrifice. Using salary sacrifice means it costs only £58 to pay £100 into your pension
• Higher-rate taxpayers who receive child benefit could save up to 73% tax by increasing their pension contributions, due to the combined impact of tax saving and reducing the high-income child benefit charge.

Assumptions – based on thresholds rising with CPI inflation of 6.7% (normal basis for threshold uplift in September 2023) and wages rising by 6.2% based on ONS wages data for December 2023.

Alice Guy, Head of Pensions and Savings at interactive investor, says: “With the budget only days away, our analysis shows the stark impact of fiscal drag on take-home pay, with the personal tax burden of all taxpayers due to increase next year. But paying more tax also means that understanding the benefits of pension saving has never been more important.

“If you can afford it, then increasing your pension payments is a great life hack and one of the best ways to reduce your personal tax burden. Because pension payments are tax free, you’ll get to save income tax on any contributions you make. For basic-rate taxpayers who also use salary sacrifice, it only costs £70 to pay £100 into your pension, and for higher-rate taxpayers, it’s an even better deal, costing just £58 to pay in £100 into your pension.

“Using salary sacrifice to make pension contributions is a win-win, allowing both employees and employers to save up to 10% national insurance as well as income tax, potentially saving up to 10% extra tax on pension contributions. And employers can save 13.8% employers’ national insurance because the pension payment under a salary sacrifice arrangement isn’t officially counted as part of the employees’ pay.

“For higher-rate taxpayers with kids, paying more into your pension could help you save up to 73% tax. That’s because the high-income child benefit charge is based on your income after pension payments. Higher-rate taxpayers with two kids have a marginal tax rate of 64% on earnings between £50,000 to £60,000, due to gradually losing child benefit on top of 40% income tax and 2% national insurance. Meanwhile, higher-rate taxpayers with three kids have a marginal tax rate of 73% on earnings between £50,000 to £60,000.”

Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “While there is a great deal of uncertainty over tax cuts ahead of the Budget, one painful certainty for workers is any tax saving will be eroded because of a deep freeze of tax thresholds and allowances which, in tandem with wage inflation, means we’ll be paying more in tax in the years to come. It is a sneaky tax grab, as people might not realise they are paying more in taxes simply due to inflation, making it seem less transparent compared to explicit tax increases.”

“The burgeoning tax burden provides extra impetus to look carefully at various aspects of your finances and tax planning. While salary sacrifice can help mitigate the tax burden, it is important to note that a lower salary can affect entitlements such as maternity/paternity pay, mortgage applications based on one’s income, and some state allowances. As such, people should always consider how such benefits could impact their finances more broadly.”