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Are Pensions The Most Tax-efficient Way To Save?

Chris O'Connor17 October 2022

Pensions are a great, tax-efficient way to save for your future. But they’re not the only option if you’re looking to grow your cash effectively.

Read on to find out what you need to know about pensions and the alternatives to help you save in the most efficient way.

Pensions - the basics

For many people, saving into a pension is one of the most tax-efficient ways to grow your money because of the tax breaks associated with them:

  • You get income tax relief as the money goes into your pension, giving you an extra 20% on top of your contributions (called “relief at source”). If you're a higher or additional rate tax payer, you can claim a further 20-25% income tax relief.
  • You won’t be charged income tax or capital gains tax as your pension grows.
  • You can withdraw 25% of your pension without paying tax on it.
  • There’s no inheritance tax to pay if you pass your pension on when you die.

Having said that, there are a few things to remember if you want to keep your pension contributions tax-free:

  • You can save a maximum of £40,000 (your annual allowance) per tax year in your pension. Anything above this and you’ll have to pay tax.
  • Your pension savings can’t go above your annual earnings each year or you’ll need to pay tax.
  • Your lifetime allowance for tax-free savings is £1,073,100. You’ll need to pay tax on anything over this.

Once your income hits £240,000, things start to get a bit more complicated as your annual allowance begins to reduce.

Pensions when your income is more than £240,000

If you earn more than £240,000 in taxable income, the government starts to restrict tax relief on your pension contributions. This figure includes money coming in from all sources, like interest and rental properties.

For every £2 of income over £240,000, your annual allowance reduces by £1. For example:

You earn £260,000, which is £20,000 more than £240,000. Your annual allowance will decrease by £10,000, giving you the ability to contribute £30,000 without a tax charge.

Once you reach a total income of £312,000, the government caps the reductions on your annual allowance. Anyone earning more than £312,000 will be able to contribute £4,000 per year to their pension without a tax charge.

How do I make sure I save beneath my annual allowance?

If you’re employed, the first thing to do is speak to the person who manages your workplace pension. Check how much you’re contributing and how much your employer is contributing per year, and work out if this will come to more than your annual allowance.

Lots of employers will be set up to handle these sorts of situations. Ask if they can be flexible and change your remuneration package to reduce pension contributions and make up for it elsewhere. They may also be able to cap your contributions before they hit your annual allowance.

If you’re self-employed, the best thing to do is speak to your accountant or financial planner to make sure your pension contributions don’t go over your annual allowance.

What alternatives are there for tax-efficient savings?

For anyone earning more than £240,000, you’re facing the prospect of being able to save less into your pension tax effectively. So what are the options for your savings?

The answer is it completely depends on your circumstances and how much you’re looking to save. Working with a financial planner is the best way to understand your options when it comes to tax-efficient savings and which ones fit your life and goals the best. But there are a few general tips everyone can follow:

  • Carry unused pension allowances forwards. If you haven’t used your previous year’s allowances, you can carry them over. Do this for the last three years to save more money with the usual pension tax reliefs.

  • Pay into an Individual Savings Account (ISA). You can save up to £20,000 tax-free into an ISA each year. Plus, there are additional allowances available to get a kick-start on the little one’s savings using Junior ISAs. You can use an ISA to either invest or save while paying zero tax on any gains or income.

  • Use a General Investment Account (GIA). There’s no limit to how much you can add to a GIA. You have a dividend allowance of £2,000 and a capital gains tax allowance of £12,300 to help you grow your assets tax effectively.

  • Look for tax-reducing investments. The UK government offers bonuses to people investing in some sectors to help these areas grow. Investing in small businesses or industries like renewable energy could give you up to 50% income tax relief. Plus, dividends and capital gains may be tax-free too. Investing in smaller companies and similar are high-risk options. It’s important to think about your risk tolerance when considering these kinds of investments, so it’s best to work with a financial planner.

Pensions are just one of the ways you can make tax-efficient savings. Want to make sure you’re making the most of your money each year? Get in touch to find out how we can transform your financial planning.


This blog post is a marketing communication for information purposes only and is not intended as an offer or solicitation to buy or sell any particular financial product. Personal opinions may change and in producing this article we have not taken into consideration any individual circumstances, therefore it should not be seen as advice or a personal recommendation.

Any references to past performance should not be taken as a reliable indication of future returns. The value of an investment, and any income from it, can fall or rise. Fees and commissions may have not been expressly indicated, and you should take into account the effects that these have on the performance of a financial portfolio.

Octopus Wealth is authorised and regulated by the Financial Conduct Authority.

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