Personal Pensions - Tax Breaks

Saving for your pension via a pension plan is one of the most tax efficient things you can do.

Here's a summary of the main pluses and some minuses:

Total relief from income tax at your highest rate of taxfor all contributions into the pension scheme. So, if you invest £100, you'll effectively only pay £60 if you're a 40% taxpayer. And you'll pay £78, if you pay tax at the basic rate of 22%.

Pension funds may not reclaim the tax credit on dividend payments but there is no capital gains liability on savings in a pension fund. Put another way, once your net monthly or annual contributions have been handedover to a life insurer for investment, the government boosts the amount you've invested and then gives a little helping hand as your pension pot grows.

When you reach retirement , with a bit of luck you'llbe sitting on a healthy looking pot of pension money - you have the choiceto take part of it, up to 25%, as a 'tax free' lump sum, while the remainderof the fund may be used to purchase an annuity of some kind. You may opt to draw income out of your pension funds and defer purchasing an annuity until age 75. Among the drawbacks of investing in a personal pension plan are that you cannot normally get at your investment funds until you're 50 and that your pension income is taxable. You may only ever access a portion of your pension savings as cash. Most of it must ultimately be set aside to buy an annuity.

See our guide to pensions.

Last Updated: April 2008 © Moneyextra.com

Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.