The reason to encourage pension contributions from the government’s point of view is to get more people to save for their old age and so to not be dependent on the state.

But the reason to make pension contributions from our point of view is to minimise the amount of tax we pay over our lifetimes.

After all, we can save for old age in all manner of ways. Locking up money within a pension therefore requires an extra incentive – and the opportunity to save tax is that push.

In principle, defined contribution (DC) pensions are pretty simple:

You contribute to your pension ‘gross’ of tax (i.e. before income tax is taken off).

Your pension pot grows tax-free.

Finally, you pay tax on the withdrawals at the time you take them.

All else being equal (especially your tax rate while working and your tax rate in retirement) this is a tax deferral strategy.

Pensions only turn into a tax mitigation strategy when we get a higher rate of tax relief on pension contributions than we pay on drawing the income in retirement.

As finance nerds, we want to maximise the ‘spread’ between these two rates, with as much money as possible, with the least possible risk. 

Show me the OAP money!

With the abolition of the pension Lifetime Allowance (LTA) – which we’ll come to – I sat down to work out the optimal pension contribution strategy.

It should have been easy, right?

All you need to do is:

Work out your marginal tax rate to drawdown money from your pension in retirement as a function of pension pot size.

The bigger your pot, the more income you’ll need to draw, and the higher your tax rate on drawings. 

Discount those pot sizes back to today using your expected investment return in the pension.

If your current marginal tax rate is above the extraction tax rate for the pension pot size that you currently have (discounted back to today), then make contributions. Otherwise don’t. 

Hence all I needed to know was: when I’ll retire, the tax regime that will be in place then, how long I’ll live, and what my investment returns will be before and during retirement. 

Ahem. Perhaps not surprisingly: I failed.

However my analysis turned up some titbits that I’ll share today in the hope they’ll help some of you, too.

A recent Monevator poll showed a majority of our readers are higher- or additional-rate taxpayers.

And with income tax thresholds frozen and inflation dragging more people into higher tax brackets that number is only going to grow.

Rich people’s problems

What we’re trying to optimise with our pension contributions is this:

Now, for the purposes of this post we’re going to pretend that we live in the idealised world of finance professors.

In this textbook world we can:

Move money across time at the same discount rate.

Borrow, lend, and invest arbitrarily large amounts of money at this rate.

Afford to make tax optimal pension contributions without considering anything else.

Therefore the only consideration we are making in this article is maximising the spread between contribution tax relief and the tax rate on extraction.

This is a highly simplifying assumption. But it is a reasonable approximation for fairly rich people. For everyone else, not so much. (You can’t buy food with money you’re not going to get for 20 years.)   

I’ve also sort of implicitly assumed that you’re making decisions about pension contribution rates after you’ve already filled your ISA (and your spouse’s).

This is also highly unrealistic. It’s quite an ask to come up with £40,000 of post-tax income to put in an ISA, whilst also making maximally tax-efficient pension contributions.

Happily though, that is my situation and therefore the one of most interest to me.

For most people there’s a trade-off between ISA and pension contributions. The discussion that follows might help you weigh up the balance for your own situation.

Please note and to avoid me having to repeat myself: everything I’ve written below is under the current rules. (Until we talk about future policy uncertainty, clearly.) 

Also remember that the tax code is thorny and everyone’s circumstances differ hugely.

Get professional tax advice if you need it. This article is all just food for thought.

The basics: direct contributions vs salary sacrifice

Let’s start at the beginning. How do you best pay into your pension?

Direct contributions

You write a cheque to your SIPP provider for £80 and they gross it up by the basic tax amount. Which means you end up with £100 in your SIPP.

This is a ‘net contribution’ of £80 and a ‘gross contribution’ of £100.

The distinction is important when we get to the limits on contributions and so on, because what counts is the £100 number, not the £80.

Now, if you are a basic-rate taxpayer that’s it. You’re all grossed-up, so to speak.

If you’re a higher-rate taxpayer or above, however, then you report this (gross) contribution on your tax return. HMRC adjusts your (gross) income down by the amount of the (gross) contribution, and you’ll be owed a refund.

For example, if your marginal tax rate is 40%, then you’ll get a  refund of £20 on your £100 gross. Which makes the effective ‘cost’ of putting £100 into your pension just £60.

You write a cheque for £80, you have £100 in your pension, and you get a cheque back from HMRC for £20. Net cost: £60. 

That the contribution is used to ‘reduce’ your income from a tax point of view is important.

Crucially, if you’re in the 60% tax bracket – between £100,000 and £125,140 – then you effectively get 60% tax relief on your contributions. (Because reducing your income gets some of the annual allowance ‘taper’ back, which is the cause of the 60% rate in the first place.)

For completeness, if you’re a 45% taxpayer:

You’ll get £25 back from HMRC when you file your tax return. 

Taxed from every angle

In practice, you may find you pay multiple rates of tax relief from a single contribution.

For example, if you earn £150,000 and make a £60,000 contribution, that contribution will experience tax relief in part at 45%, 60% and 40% rates:

Salary sacrifice

The other way to make pension contributions is to sacrifice some of your salary. Here you instruct your employer to pay some proportion of your pay into your pension scheme instead of to you.

The important difference with this arrangement is that there is no National Insurance (NI) due on this payment, because it is not ‘pay’.

Now nominally this might not sound like a big deal. Employees NI is only 2% (mostly).

Still every little helps, as you can see in the table below.

But you saving a few quid is not why your big-hearted employer is always sending you emails extolling salary sacrifice as a way to pay for electric cars, bikes, pensions, and goodness knows what else.

No. Your employer is motivated by the 13.8% employers’ NI that it doesn’t have to pay on whatever you salary sacrificed into your pension.

Your employer saves £13.80 per £100 of salary sacrifice. So probably the most important question in this whole post is: can you get your employer to share some of that money saved with you?

Well, can you?

It depends. Some employers do it by default. Others don’t. And some – big and small – will negotiate.

For my part I’ve successfully negotiated a sharing of these savings either firm-wide or as a special deal for me (“I won’t tell anyone else”).

You do have some leverage. After all, you can just make a direct contribution. It’s 2% more expensive for you, but 13.8% more expensive for them. When we approach the limits of maximising the amount of tax we save it turns out it’s highly sensitive to the ability to clawback some employers’ NI, so I’d encourage you to go for it.

Usually, any sharing of these savings goes into the pension contribution, rather than as (taxable+NI) cash to you – otherwise the process is a bit circular.

This makes the maths a bit weird, because we’re now ending up with £113.80 in the pension for each £100 of salary sacrifice:

If we renormalise that back to the cost of £100 in the pension we get this: 

The ‘gross contribution’ if you sacrifice £100 of salary and your employer pays £113.80 into your pension is £113.80, not £100. 

If we’re hitting our peak tax mitigation potential – that is, inside the 60% bracket – then we are foregoing just £33.39 in net pay to get £100 in our pension.

Employer matching

There’s a legal obligation for your employer to make pension contributions on your behalf, and to deduct a minimum contribution from you. It is usually something like they pay 4% and you pay 4%.

You can opt-out of this (I believe…) but why would you? It’s pretty much free money.

Given that your employer-matched contribution is processed as salary sacrifice, you end up with this: 

There’s pretty much no extraction tax rate on drawdown that would render these contributions not worthwhile.

Indeed, during my pension wilderness years enforced by the LTA, the employer match was all I did. 

Employer pension schemes vs SIPPs

A common complaint I hear about salary sacrifice (SS) is that you can only SS into your employers’ chosen pension scheme.

The scheme with poor investment choices, obscure fees, and a website unchanged since the late 1990s.

Well yes but this is trivially surmountable. Just set the investment choice in the company scheme to ‘cash’ and every six months or so transfer that cash from your company scheme to your favoured SIPP.

Your company won’t care. (Probably.)

Contribution limits

There are limits to how much you can contribute to your pension.

The limit is the lower of:


Your total employment income

Note this limit is on the size of your gross contribution. 

The £60,000 limit is ‘tapered’ (it becomes less) if you earn over £200,000 – or £260,000 because the rules are, inevitably, pointlessly complicated. 

There is also a mechanism called carry back that allows you to carry forward (I know…) your unused allowance from previous years, for up to three years.

Handy if your earnings are very volatile.  

Summary: getting the money in 

We’ve established the cost of getting money into our pension scheme:

It’s worth noting that if you’re subject to the ‘High Income Child Benefit Charge‘, have things like childcare tax-credits, or you earn income from residential property (with a mortgage) then your marginal tax rate could be higher.

It might even exceed 100%. 

An example of what not to do: what I did

The challenge is that you don’t know the future. Specifically, you don’t know your future earnings.

You want to concentrate your contributions in years when you have the highest marginal tax rate.

But when will that be?

What you really want to avoid is a situation where you’re getting tax relief at, say 40%, but you could (later) fill your pension with tax relief at, say, 60%:

This is not far from my situation actually.

High earnings and acute imposter syndrome early in my career meant I contributed large sums to get 40% tax relief.

Later on I didn’t contribute – even though I could have got 60% tax relief – because I was over the LTA.

In my defence, when I made those original contributions the maximum income tax rate was 40%. We didn’t have the 60% band. Indeed, we didn’t have the LTA!

Still, I should have been more patient. 

This rather emphasises the point that over long time periods there’s enormous policy uncertainty.

The pension pot then grows tax-free…

…or does it, really?

I would argue not.

Sure, from an administrative point of view you don’t have to pay capital gains on any gains or income tax on dividends (except on some foreign dividends).

However in the end you will have to pay income tax on your gains – even if those gains only kept up with inflation.

And income tax rates are higher than both capital gains tax and dividend tax rates.

Then there’s the possibility that the government will just decide to confiscate some or all of the gains, in this supposed ‘tax-free’ wrapper. Which they have done before with the LTA. 

So, I’m unconvinced.

Given there exists a perfectly good actual tax-free wrapper – the ISA – I would argue that the allegedly ‘tax-free’ growth in the pension is not, by comparison, tax-free. 

The ‘tax-free’ ness of investment returns in the pension pot should be ignored when considering the spread between inbound tax relief and outbound tax paid.

This is not to ignore the impact that investment growth has on our capacity to withdraw under certain tax thresholds, or to be subject to any future LTA charge. These considerations do very much matter. They should feed into our estimates of the extraction tax rate.

Perhaps a reasonable base case is that our investments keep up with inflation, but that tax allowances do not. (Reasonable because this has been the situation for many years).

Cashing out

At last the fun bit!

Kerching! Et cetera et cetera.

Actually, while spending your pension pot is certainly more agreeable than doing without in order to fill it, in the meantime we’ve yet more maths to do.

Moreover it turns out that working out the tax relief we’ll get in on the way in was the easy bit.

Now we need to guess estimate work out our marginal tax rate in retirement, when we come to extract that cash from our pension. 

The tax-free lump sum

Thanks to the pension commencement lump sum (PCLS) – sometimes just called the tax-free lump sum – you can withdraw 25% of your pension tax-free, up to a limit of £268,275.

Effectively if your pension pot is going to be worth less than £1,073,100, then you can just assume your tax rate for withdrawals is 75% of your actual tax rate.

For example, you retire with a £1,000,000 pension pot. You pull £250,000 out tax free, and pay 20% on the rest (by spreading the withdrawals over many years).

Your marginal tax rate will be 75% of 20% = 15%

Great, that’s lower than the rate of tax relief we got putting the money in, regardless of the circumstances. (See the chart above. The lowest amount of tax relief possible is 20%). 

Getting a camel through the eye of a needle

The larger your pension pot though, the harder it is to drawdown at low tax rates.

In fact, given the low threshold for higher-rate tax (£50,270), your investment returns can be mediocre and yet you can still reach (non)escape velocity – where you’re only drawing down investment returns, and never ‘shrinking’ the pot. 

If you do need to choose between pension and ISA savings then you also need to think about this dynamic. Don’t just pour all your savings into pension contributions. Because of the cap on the PCLS, the key inflection point is when your projected pot is on target to exceed the old LTA limit of £1,073,100.

Summing up

Putting it all together, we can calculate the ‘P&L’ in tax savings. By which I mean the number of post-tax- pounds we’re better off as a function of tax-relief on the way in and tax-rate on the way out…

…depending on if our pot is below the old LTA limit:

…or above it (LTA extraction rate at 55% included for completeness):

Avoiding over-saving

A shortcut is to think about worst case scenarios. In particular, what we’re trying to avoid is the situation where we’re paying a higher rate of tax on withdrawing than we got in tax relief:

Don’t touch it

There’s another option to consider, too.

People who are lucky enough to have lots of other assets to draw on can simply never draw their pension down at high tax rates. They can just leave it in there, growing.

Your beneficiaries can then draw it down at either 0% or their marginal tax rate, when you are gone. It’s outside your estate for IHT purposes.

We’ll discuss this a bit more below, because I believe it is very likely these rules will be changed.

For me personally – with kids, and with about a 25% change of dying before the age of 75 (and a 100% certainty eventually) – this is quite a valuable benefit.

But won’t they change the rules again?

Yes of course they will.

So what tinkering might we anticipate in advance?

Reintroduction of the Lifetime Allowance

Bringing back the LTA is an odds-on favourite because the Labour Party immediately committed to its reintroduction when the Tories abolished it. (At least, for everyone who doesn’t work for the NHS.)

With that said, they’ve not been particularly vocal about it since. Perhaps now that the detail about the limit on the tax-free lump sum has sunk in it seems less of a priority?

After all, if you’re constraining the amount of tax-relief that high earners can get on the way in, and the amount they can get out tax-free, it’s not obvious that the LTA justifies its considerable complexity.

On balance I think it’s likely that a long period of ‘consultation’ about pensions will ensue. If they don’t re-introduce the LTA then that consultation is likely to include at least one of the other possibles I’ll get to. 


Don’t save too much in your pension. Focus on those very high tax rate years.

Only contribute if your tax relief on contributions is so high that you’ll still come out ahead even if you’re subject to the LTA charge .

Historically there have been ‘protection’ regimes available if the value of your pension is above the LTA when they introduce it. This is so they can pretend that the LTA is not, effectively, retrospective taxation. (Although of course it is, even if you’re below the LTA limit when it gets introduced).

Have the lower return assets in your pension and higher return assets in your ISA. (You should do this anyway.)

Changes to inheritance tax treatment / beneficiaries pensions 

As we’ve seen, one of the major benefits of getting money into your pension is that, under the current rules, it’s outside of your estate for IHT purposes.

I have discussed previously how wealthy families are already using this as an inheritance tax avoidance strategy. (That earlier post also goes into the mechanics of how). For those who are still working and whose estates would likely be subject to IHT, this is a very attractive planning vehicle. It enables them to get very high rates of tax relief. The result is a highly tax-efficient ‘trust fund’-like pot, which either they or their heirs can access.

It’s unlikely, for legislative reasons, that pensions will be brought inside the IHT net. The most likely change is that full tax-free withdrawal by beneficiaries if the benefactor dies under the age of 75 will be removed, and the same rules apply regardless of their age at death.

Indeed this might actually happen anyway as part of the LTA abolition.

Pensions would still remain very useful from an IHT planning point of view. The beneficiaries can drawdown when their marginal tax rate is low, for example. Or they can just treat the whole thing as an emergency fund that they can get at if they really have to (and pay the tax to access it). 

Over the long run I doubt having ‘beneficiary’ pension pots that can compound tax-free for decades or even centuries would survive the “So-and-so has £1bn in their pension” headlines. We are not America.

Talking of America, another proposal occasionally raised is to force beneficiaries to take a certain fraction of their pot as taxable income every year. These are called required minimum distributions.

But let’s not give our politicians any ideas by discussing that further here, eh?

Flat-rate tax relief

The tax-saving benefits of pension contributions rise with your earnings, thanks to higher rates of tax relief. Because of this, many people consider the tax planning we’re discussing today as inherently ‘unfair’.

Critics argue the purpose of tax relief is to try to ensure you aren’t a burden on the state in your old age.

But high earners will save for their retirement anyway. They don’t need a tax incentive.

In contrast, because they get less tax relief, lower income people have less of a motivation to save. Yet these are also precisely the people who need more encouragement to do so.

The solution often posed by left-leaning think tanks is to offer tax relief on contributions at a ‘flat’ rate. Somewhere above the 20% basic rate, but below the 40% rate. Typically 30% is proposed.

Such a flat rate would give less tax relief to the rich and more to the poor.

Full disclosure: I’m quite sympathetic to this argument.

There would be quite a lot of complexity involved in implementing it – especially for those in Defined Benefit (DB) schemes. However, since the remaining DB schemes are pretty much all in the public sector, there’s no reason (other than fairness) as to why there shouldn’t be a different (more generous) tax regime for them.

If we can have a different tax system for people in the NHS, why not for all government employees?


If you think flat relief is coming, your action depends on the tax relief you currently get on contributions:

Are you a higher / additional / 60% rate taxpayer? Then you should max out contributions that get tax relief at those rates because in the future tax relief would be lower. 

Are you a  basic-rate taxpayer? You should make minimal contributions now. Aim to increase your contributions when the flat rate is introduced. 

Elimination of the income tax allowance taper (60% rate)

We can all agree that having a 60% rate in between the 40% and 45% rates is ridiculous, yes? So it’s not completely impossible that some future government will agree.

Labour has committed to not raising income taxes when they form the next government. I imagine they shan’t be lowering them either!

But in a second parliament they might eliminate the taper as a quid-pro-quo for increasing additional rate tax to 50%, for example.


If you’re a 60% taxpayer then pay the 60% slice into your pension, because that relief might not be available in the future. The same slice might only attract relief at 40%, 45% or 50% someday. 

Generally higher income tax rates

A penny on income tax to “save the NHS”. Another one for “care”. Another one for our “brave boys and girls fighting in some foreign war”. Oh, and another one to send some poor sods to Rwanda.

You know the drill. Taxes pretty much only go up, as state expenditure increases faster than the size of the economy. I believe this is is best tackled by increasing the size of the economy. But growth seems to be even less popular with voters than high taxes, that are, anyway, mostly paid by someone else.

If income taxes are going up over the long term, then the last thing you want to do is defer your income tax until later. You’d be better off paying tax now.


Don’t save into your pension except at very high tax relief rates. 

Crazy things that a government might consider

All those potential revisions to the pension system seem somewhat feasible to me.

But the longer you’ve got until retirement the crazier it could get.

Here’s just a random assortment of crazy ideas you see kicked about:

Means testing of the state pension – based on private pension ‘income’. This would favour ISA savings (which likely wouldn’t be counted) over pension income (which would). 

Means testing of the state pension – based on ‘wealth’. Possible that pensions wouldn’t be counted, but ISAs would (as they are for some wealth-based benefits, such as unemployment benefit). Favours pensions contributions over filling the ISA. 

The integration of NI and income tax. This obviously makes sense, because they are both just a form of income tax. A properly brave government would wrap employers’ NI in too. (Although if people really knew how high tax rates are…) The pay-off for this bravery would be much higher income tax rates which could also be applied to ‘unearned’ income such as income from pensions. Favours ISAs over pension saving.  

ISA lifetime allowance. I wish John Lee in the FT would stop banging on about how much he has in his ISA. Because seriously, why draw attention to it? Some sort of cap on the value in an ISA that’s eligible to be tax-free would be retrospective and highly complex to administer – but when has that ever stopped them? Obviously favours pension saving over ISA saving.

ISA allowance cut (or a real terms cut through fiscal drift). Favours getting cash in your ISA while you can and leaving pension savings until later. Perhaps when you’re on a higher marginal tax rate?

Special tax rates for pension income / an ‘Unearned Income Surcharge’. Factor in employers’ and employees’ NI, and people in employment pay much higher tax rates than the retired. This is unfair. Rather than rolling NI into income tax, you could address this by taxing pension income at a higher rate than employment income. This has less behavioural impact, because while employed people will work less if you tax them more, retirees have no choice but to live off their pensions. Favours ISA saving over pension saving.

How to model all these risks? We can’t really. You will have to make your own assessment.

The best insurance policy is to focus your contributions where you get very high rates of tax relief. That way you will probably come out ahead in most circumstances. 

Tips and tricks with pension contributions

There’s always something more to do with a tax code as complicated as ours!

Keep it in the family

Make sure you plan your pension savings holistically with your spouse. Let’s say you stop working for a decade while the kids are small, but your partner keeps working. Once you go back to work you are both higher-rate taxpayers. You have a pension pot of £200,000 and your partner has one of £800,000.

Clearly, because of the PCLS cap, as a couple your pension contributions should take priority over that of your partner’s.

Similarly, if both your pension pots are small and one of you can get your employers’ NI through salary sacrifice and the other can’t… you know which one to prioritise.

Maybe you should even think about pensions from the perspective of your whole family, as we showed previously

How to get 60% tax relief if you’re a 45% rate taxpayer 

You earn £190,000 a year. You make the maximum gross contribution of £60,000 a year. This brings your taxable pay down to £130,000.

So you’re only getting 45% tax relief on the contribution. And you are paying 60% on most of that £30,000 above £100,000:

Is there something we can do to improve this situation? Well, yes, of course, otherwise I wouldn’t have brought it up.

By using ‘fallow’ years – where we don’t make a pension contribution – we can use ‘carry back’ to carry forward the unused allowance from the fallow year to make a contribution that eats into our 60% tax rate.


This saves us £22,626 of tax over a nine-year period – £2,514 per annum – just for being organised. 

Fill your ISA with your PCLS / tax-free amount 

You want to max out your pension contributions in the last few years before age 55? This doesn’t leave you enough cash to fill your ISA?

Then you can do something like the trick I showed previously. But beware of the ‘pension recycling rule’. 

The pension recycling rule

Not targeted at my trick linked to above particularly, but if you increase your pension contributions ‘significantly’ prior to taking your tax free-amount, then HMRC has a special rule aimed at clawing back your tax relief.

Called the recycling rule, it’s designed to… stop you using pension contributions in exactly the way that Parliament intended you use them.  

Scaling salary sacrifice

Is your employer paying its NI savings into your pension? Make sure that the amount you’re reducing your salary by (to get into a lower tax bracket, for example) is less than what’s going into your pension (as used to calculate the annual contribution allowance).

For example, let’s say you earn £160,000 and you salary sacrifice £60,000.

Your employer will be paying £68,280 into your pension, including the NI savings. This is £8,280 over the annual allowance – unless you’re using carry back.

The maximum salary you can sacrifice within the annual allowance is: £60,000/1.138 = £52,724.07.

This will leave some of your earnings exposed to the 60% tax rate. Be careful.


There are almost no circumstances where contributions to your pension that attract 60% or higher tax relief or employer matching contributions will leave you worse off in the long run. That’s true even if the LTA is re-introduced in its old form.

Capturing some of the employer NI as part of your tax relief can make a big difference. 

The larger your pension pot, the more you need to think about policy risks.

Once your pension pot is over four-times the PCLS limit, there’s little point in making direct contributions at 20% tax relief.

Made it this far?

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