More than half of higher-rate taxpayers are missing out on pension tax relief on their contributions, averaging £1,020 a year. Worse still, poor planning means many are then needlessly paying too much on their post-retirement income, too.
Analysis by Prudential shows six out of 10 higher-rate taxpayers (those earning over £42,500) are failing to claim the full 40 per cent pensions tax relief to which they are entitled.
The problem is most acute for those higher earners who pay into personal pensions - such as group personal pensions, self-invested personal pensions and stakeholder schemes - rather than occupational plans.
This is because occupational pension scheme members have their tax relief awarded through payroll, but many other arrangements require the member to request it directly from Her Majesty's Revenue & Customs (HMRC) through, for example, a self-assessment form.
Vince Smith-Hughes, retirement income specialist at Prudential, says few higher-rate taxpayers complete a self-assessment tax return, nor are they prompted by their employer to do so.
The missed claim opportunity can also affect those who are new to self-assessment, "especially employees who have moved into higher-rate tax bands due to a pay increase and would not have had to complete a tax return before", says Claire Menni, associate at chartered financial planner John Lamb LLP.
But all is not lost for anyone who, until now, has been unaware of their pension tax relief entitlements. It is possible to claim backdated tax relief for up to three years and, for those not required to complete a self-assessment, they can simply produce a standard letter for HMRC detailing the contributions made.
Philip Smith, head of defined contribution and wealth at Buck Consultants, says it's important to ask your pension provider for a record of the contributions paid during your pension input period (the 12-month period over which your pension contributions are measured), and urges: "Don't wait until you fill out your tax return to claim any extra higher-rate relief."
Tax matters post-retirement
Getting your pension tax affairs in order in the run-up to retirement is not enough on its own to optimise your income throughout your retirement, however.
Recent analysis by MetLife reveals that the taxman takes an average 29 per cent chunk from pensioner household incomes through both direct and indirect taxation (this figure rises to 42 per cent for households in the bottom decile).
But such losses can be mitigated. For one, Prudential’s Mr Smith-Hughes says many retired couples are missing a trick when it comes to the higher tax-free personal allowance available to them. The allowance for each individual is currently £10,500 for those aged over 65, so a simple restructure of both parties' investments means couples could take advantage of the full £21,000.
"The prize of £21,000 per couple of tax-free income is a good one, and worth planning for both in advance of and at the point of retirement," he says. However, he warns this may involve having to reduce one party's pension contribution to fund the other, and he urges people to seek advice.
Also note that changes to the higher personal allowances were announced in Budget 2012.
From 2013-14, the availability of the 'age-related' income tax personal allowances will be restricted. The allowance of £10,500 for 2012-13, available to people aged 65 to 74, will be restricted to people born after 5 April 1938 but before 6 April 1948. The allowance of £10,660 for 2012-13, available to people aged 75 and over, will be restricted to people born before 6 April 1938.
From 2013-14, the amounts of these allowances will not be increased. From 2013-14, people born after 5 April 1948 will be entitled to a personal allowance of £9,205 for 2013-14.
This measure supports the government's goal of a single personal allowance for all taxpayers regardless of age, and to spread tax relief fairly across working-age people and pensioners.
Stephen Lowe, director at retirement income specialist Just Retirement, highlights that the higher tax band can still pose problems in the twilight years as some retirees may have part-time jobs or sources of income that could move them into the higher bracket. He recommends income drawdown as a possible solution. "It is used by some retirees to control the level of income they extract from their pension fund to ensure they fall below the higher marginal tax limits," he says.
Thinking about alternative ways to receive your pension benefits is key to keeping your tax bill as low as possible. One option, says John Lamb's Ms Menni, is the phasing of retirement so that annual income is made up of a mixture of tax-free cash and some taxable income.
"Another pitfall is that those turning 75 who haven't yet crystallised their pensions must do so before their 75th birthday, so they don't lose the right to take 25 per cent as tax-free cash," she adds.
The pacing of that tax-free cash is also crucial, contends Buck's Mr Smith. He says pensioners should deviate from the traditional route of taking the lump sum and arranging income using another vehicle. "Don't take your tax-free cash all in one go, think about using it as part of your income stream," he says. "That way you can keep your tax bills down and leave your money invested in your pension, where it grows in a tax-advantaged environment."
Finally, as well as reworking your income to ensure you remain a basic-rate taxpayer and using pension tax relief allowances available to couples, he also urges individuals to make full use of any capital gains tax entitlements where possible.
