Example 1 – Net cost and benefit of a pension contribution (1)
Joe earns £60,000 a year
and is 55 years old. He can contribute up to 100% of relevant earnings, subject
to a maximum of £40,000 in taxable earnings. He has no medical issues, and is a
non-smoker.
Gross Contribution £20,000
HMRC uplift at 20% £ 4,000
Net contribution by Joe £16,000
Joe takes 25% tax free
cash (25% x £20,000) £5,000
Joe gets back a further
20% through tax return £4,000 (as
a higher rate taxpayer, a further 20% is reclaimable)
Total savings £9,000
Total cost of investment
£16,000 - £9,000 = £7,000
Balance of fund for income
annuity for life £15,000 (at
£56.25 per month at 4.5% rate)
If Joe was age 70 he would
get £80 per month at 6.4%.
Plus he has £5,000 in
tax-free cash to spend.
Example 2 - Net cost and benefit of a pension contribution (2)
Martha is age 70. She is retired and needs to invest for
income. She can contribute a maximum of £3,600 gross, £2,880 net to a personal
pension plan, without earned income. She has no medical issues.
Gross Contribution £3,600
HMRC uplift at 20% £ 720
Net contribution by Martha £2,880
Martha takes 25% tax free
cash (25% x £3,600) £900
Total cost of investment
£2,880-£900 = £1,980
Balance of fund for income
annuity for life £2,700 (at
£14.40 per month (6.4% return))
Plus she has £900 in
tax-free cash to spend or direct to income.
Variations
You have a number of choices – you do not need to take tax-free cash immediately – you can let your funds grow and then take tax-free cash. You can even take the tax-free cash and defer the income.
Medical issues, smokers, etc.
The annuity interest rates can increase from the 6.4% shown above to around 8% plus, improving income for life even further.
Practical Tip:
If aged over 55, consider the benefits of a personal pension plan as an investment. Your fund grows tax-free, HMRC adds 20% to every contribution you make, and 25% of the whole fund is immediately available to you as tax-free cash. You can take or defer income from the balance of the investment, which would be taxable (but tax free if within your personal allowance).
Please note that the pension rules are complex, and professional advice is strongly recommended. In addition, the above examples are for illustration purposes only. Investment advice should be obtained from a suitably qualified and experienced financial adviser, based on your own personal circumstances.