Following the 8.5% rise in the annual State Pension from 6 April, the redirection of this enhanced income into private pension savings could make sense under certain conditions. The idea of investing one’s State Pension into a personal or Self-Invested Personal Pension (SIPP) might seem at odds with conventional wisdom.

Given its foundational role in providing retirement income and ensuring the financial stability of numerous retirees, diverting funds in this manner could initially appear to be misguided. Yet, there are distinct scenarios where such an investment could provide significant tax benefits, particularly for those who have attained State Pension age but continue to generate additional income.

Continued employment’s impact on retirement planning
Upon reaching the age of 66, individuals are entitled to their State Pension, which currently peaks at  £11,502.40 annually. While many may have retired by this point, relying on this sum as their primary or supplemental source of income, there is a growing trend of individuals who do not immediately need these funds due to ongoing employment, whether part-time or full-time.

Based on ONS labour market data, recent findings from the Centre for Ageing Better show that more than one in nine people aged 65 and above remain active within the UK workforce – a statistic that has seen a significant increase since the year 2000[1]. For these senior workers, the reinvestment of their State Pension – or a corresponding portion of their wages – into a private pension can be an appealing strategy. This approach allows for the enhancement of their retirement reserves and enables them to maintain a comfortable standard of living on their current earnings.

Navigating tax benefits and contributions
The existing regulations allow for contributions of up to 100% of one’s earnings or £60,000, whichever is less, into a pension scheme each tax year, with the opportunity to receive tax relief on these amounts. Furthermore, carrying forward any unutilised allowances from the previous three tax years for those whose earnings exceed £60,000 is feasible. This policy remains effective until the age of 75, after which individuals no longer qualify for tax relief on pension contributions.

This method is particularly advantageous for individuals in higher tax brackets as a result of continued employment beyond the State Pension age. By transferring their State Pension into a pension scheme, they can potentially lower their taxable income, thus reducing their tax liability while simultaneously enhancing their future pension reserves.

Leveraging pension investments for maximum benefit
The strategy of using one’s State Pension in a calculated manner holds multiple advantages, especially for those with surplus income that isn’t needed for immediate expenses. Choosing a pension wrapper stands out as the most tax-efficient method of managing your savings. This approach not only guarantees tax relief on the contributions made but also ensures that any investment growth, whether from dividends or capital gains, is not subject to tax.

Furthermore, when ceasing work and beginning to draw from these pension funds, individuals benefit from the possibility of withdrawing up to 25% of the pension pot tax-free. Additionally, any untouched pension assets are not included in the Inheritance Tax (IHT) calculation upon the owner’s passing. Consequently, the principle is clear: the more substantial the contributions to your pension, the more beneficial the results.

Understanding the nuances of Lifetime Allowances
Individuals must remain abreast of the changes to the lifetime death benefit allowance, which has implications for pensions exceeding £1,073,100, assuming no protections are in place. The recent modification in pension regulations has overtaken the prior limit on Lifetime Allowances, which set a cap on savings before a significant tax levy was applied. Although this cap has been abolished, beneficiaries could be subject to a 40% or 45% tax rate (individuals marginal rate of Income Tax) when accessing the pension funds remaining after the pension holder’s death as a lump sum. The choice of a financial approach should be tailored to individual circumstances, with some strategies potentially favouring upfront tax payments and making gifts.

Adjusting work and pension strategies post-retirement
The attainment of 55 years of age (increasing to 57 from 2028) offers the liberty to access pension savings, an option that may be enticing during times of employment hiatus or when diminishing working hours for caregiving or health motives. Electing to withdraw only the tax-free portion of the pension permits ongoing annual contributions up to the full allowance into one’s pension scheme, subject to earnings, in order to obtain tax relief.

Nonetheless, choosing taxable pension income through a drawdown initiates the money purchase annual allowance (MPAA), considerably curtailing the maximum pension contribution to £10,000 annually or to a figure equivalent to one’s annual earnings if it is less. For individuals who continue to work after the MPAA is triggered, utilising income which isn’t required could be contributed to a pension to use this reduced allowance.
Contributing to pensions without earnings

Individuals who receive a State Pension yet fall below the Income Tax personal allowance threshold of £12,570 for the 2024/25 tax year have the opportunity to contribute up to £3,600 gross to a stakeholder pension. These contributions are met with tax relief, augmenting the investment’s value without imposing any additional tax burden on the contributor.

This avenue proves advantageous for retirees or those augmenting their income with proceeds from a tax-free ISA. While most individuals at State Pension age may find their ability to contribute capped at £3,600 annually, it is an option worth considering. This is especially beneficial for individuals beyond the State Pension age, as it allows them to amplify the tax advantages on their retirement savings further.

Source data:
[1] https://ageing-better.org.uk/news/almost-one-million-more-workers-aged-65-and-above-millennium-new-analysis-reveals

THIS ARTICLE DOES NOT CONSTITUTE TAX OR LEGAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. TAX TREATMENT DEPENDS ON THE INDIVIDUAL CIRCUMSTANCES OF EACH CLIENT AND MAY BE SUBJECT TO CHANGE IN THE FUTURE. FOR GUIDANCE, SEEK PROFESSIONAL ADVICE.

THE FINANCIAL CONDUCT AUTHORITY DOES NOT REGULATE TAX PLANNING.