Pension Planning for Non-Earners

Many people assume that a personal pension plan is only available for those people who are in paid employment. Historically this was the case as there was a need to be in receipt of “net relevant earnings” in order to qualify for pension contributions.

This income had to be “earned” income – so if for example you had a large percentage of your income come from savings and investments then this “income” could not be used to calculate the maximum amount which you could invest in a personal pension plan.

Under current rules you are able to contribute up to 100% of your earnings, or £3,600 gross per annum, whichever is greater.

How does tax relief work on a personal pension?

All contributions made by individuals are made “net” – i.e. they are paid out of taxed income, and it is the responsibility of the pension provider to reclaim the income tax which has already been paid on the slice of income which is being invested into the personal pension.

Everyone qualifies for basic rate income tax relief at source, regardless of their tax position.

So it is therefore possible for someone who is effectively not paying any income tax, for example a parent who stays home to raise a family, to pay money into a personal pension and have this topped up by HMRC by way of a tax rebate into the plan.

What rate of relief is applied?

Basic rate tax relief is applied, currently being 20%, so in order to make a gross contribution of £3,600 into a personal pension plan, a net contribution of £2,880 is required, with the pension provider, reclaiming £720 income tax relief from HMRC – this provides a non-taxpayer with an instant return on their money invested of 25% – there aren’t many investment which can give that sort of return in the first year!!!!

Don’t forget though, with a pension plan, under current rules, at retirement you can take 25% of your pension fund as a tax-free lump sum (known as “pension commencement lump sum”) with the remainder of the fund providing a pension income of one kind or another, which will be liable to income tax.

Why is this important for families planning their retirement income?

Traditionally in a family with just one adult working, all pension planning has been done in their name – with the subsequent outcome that they will be liable for income tax on reaching retirement.

Now it is possible to fund a pension plan for the non-earner – the benefit here being that both partners will have a personal allowance in retirement, against which no income tax is payable, and therefore pension income for the non-earner in retirement, depending on their other sources of income, could effectively be received without any income tax liability.

For more guidance on pension planning for non-earners we would suggest you take independent financial advice to decide whether this course of action is suitable for your particular circumstances.