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Your quick guide to pension tax

Your pension is a tax-efficient way of saving for the future as we provide a range of options that could help you manage your tax liability

Tax relief - what is it and how do you benefit?

Tax happens – but it’s not always take, take, take. Your pension’s a tax-efficient way of saving for the future and we provide a range of options that could help you manage your tax liability.

This is a pretty good one – it’s like getting free money from the government as a reward for building your pension.

The tax relief you get is based on the rate of income tax you pay – most people pay the basic rate of 20%, so that means every £100 you pay into your pension, you pay £20 less in income tax. If you’re a higher-rate or additional-rate taxpayer, it works the same way, with your tax relief based on the rate you pay.

While you get a tax saving upfront, you will be taxed on the pension you receive once you retire, but, you can take up to 25% of your pension as a tax-free lump sum, and you’ll only pay tax on any monthly retirement (and any other) income that’s above your personal allowance – like you do now with income tax.

Limits to how much pension you can build up and receive

There are various government-set limits on the level of benefits you can build up and how much you can take, before being subject to tax charges.

The government-set limit on the amount of pension benefits you can build up in a single year is £40,000 (for 2019/20).

It’s calculated differently for defined benefit arrangements like the Retirement Income Builder, where the increase in the value of the benefits you build up is measured, and defined contribution arrangements like the Investment Builder, where it’s determined by the amount you and your employer pay in.

If you go over the Annual Allowance in a single tax year, you’ll receive a tax charge on the amount above the limit. But if you don’t go over the allowance in any of the previous three years, you may be able to carry any unused allowance forward to offset against the current year’s.

For higher earners, the Tapered Annual Allowance reduces your Annual Allowance based on your income. Check out our Annual Allowance page for more details.

This affects anyone that’s taken cash from their defined contribution savings: If you take cash from your Investment Builder pot, you and your employer will only be able to contribute a combined maximum of £4,000 a year (for 2019/20), before you are subject to additional tax. If you took cash from your Investment Builder at the same time as taking benefits from your Retirement Income Builder, this won’t apply to you.

If you have any other defined contribution arrangements outside of USS and you take cash payments from them, either as UFPLS or drawdown, the Money Purchase Annual Allowance will also apply – you and your employer will only be able to contribute up to £4,000 to all your money purchase arrangements (not £4,000 to each of them).

If taking cash from a defined contribution triggers the Money Purchase Annual Allowance, you will be informed.

The Lifetime Allowance is the government-set limit on the amount of pension benefit that you can receive without triggering an extra tax charge. For 2019/20 it’s £1,055,000 and it goes up in line with inflation at the start of each new tax year.

Every time you use your pension benefits to provide an income and/or a lump sum, you’ll use up some of your Lifetime Allowance – we’ll outline the impact of your Lifetime Allowance in the quote we provide, when you’re looking to retire.

The Lifetime Allowance doesn’t apply to your State Pension, but it does apply to all other pension benefits you build up, not just those in USS.

Managing your tax in USS

We have a range of options available to help you manage your pensions tax.

Resources

To find out more about the content covered in this article, use the following information and modelling tools:


Republished: 19 January 2021