We all want to enjoy a long and happy retirement enjoying the things we love the most. Of course, to do so we need to plan for the future and set aside enough funds. But what’s the best way to save for retirement? And are there any alternatives to pensions for high earners who face increasingly more onerous tax burdens? Read on to find out more.
The best way to save for retirement
The following are just some of the best ways to save for retirement:
- Start early – The earlier you start saving, the more your investment will grow.
- Clear debt – Paying off debts frees up more funds for your retirement savings pot.
- Stay focussed – Prioritising your pension will help you in the longer term.
- Set goals – Setting clear goals will give you the motivation to save for the future.
The problem for high earners
The annual tax-free allowance for pension contributions is £40,000. However, for high earners with a “threshold income” (your annual income before tax, minus any personal and employer pension contributions) of £200,000 and an “adjusted income” (all taxable income before tax, plus the value of your personal and employer pension contributions) of £240,000, this allowance is curtailed.
This is the “tapered annual allowance”, which was introduced by the government in April 2016. If you meet those income thresholds, then for every £2 you earn above the adjusted income of £240,000, your annual allowance will be reduced by £1. For example, if your adjusted income was £260,000, your annual allowance would be tapered to £30,000. Tapering stops at £312,000, at which point the allowance is just £4,000.
Alternatives to pensions for high earners
Given the diminishing tax efficiencies for the highest earners, other alternatives to pensions can be useful to have in your armoury. The following are just some of the options available.
In 2021/22, you can exploit your unused annual allowance dating back to 2018/19. Known as “carry forward”, this means that if your earnings are high enough, and you have not paid into an existing pension in recent years, you could make up to £160,000 of pension contributions in 2021/22 with full tax relief. This facility is particularly useful for anyone who might have had to reduce pension contributions during the Covid-19 crisis.
You can save national insurance contributions by asking your employer to reduce your salary or your bonus and use the money, including the NIC saving, to make the pension contributions for you. The technical name for this is salary or bonus sacrifice and it is perfectly legal, if you do it correctly. If you pay higher or additional rate income tax, the result could be an increase of around 18% in the amount paid into your pension.
Lifetime ISA (LISA)
If you’re aged 18 to 39, you can invest in a Lifetime ISA (LISA). For every £4 you save, the government adds £1. That means if you save the maximum £4,000 per year, you’ll receive a tax-free injection of £1,000. This bonus is paid monthly, which means you’ll also benefit from compound growth up to your 50th birthday. Bear in mind that any LISA contributions you make count towards your annual ISA limit, which is currently £20,000.
Self-Invested Personal Pension (SIPP)
A self-invested personal pension (SIPP) lets you take control of your pension investments. If you’re a business owner you may be able to use your pension to develop it more tax-efficiently. For example, you can hold commercial property and company shares in a SIPP or build up a portfolio of investments. A SIPP also offers a flexible and tax-efficient way to turn your pension fund into an income for your retirement.