< All Topics

Private Pension/SIPP Scheme Contributions Explained

What Is a SIPP?

A SIPP is a type of personal pension that allows you to control your retirement savings. Unlike traditional pensions, SIPPs provide a range of investment options, including stocks, funds, and property. They are particularly attractive to high earners due to the generous tax relief they offer.

More details on how to set up an ii SIPP through SmartWork are provided in our Knowledge Base.

What are private pension contributions?

This is an arrangement where an employee agrees to reduce their Assignment Rate in exchange for increased pension contributions from their employer. This results in a lower salary for the employee, but the sacrificed amount is paid directly into their pension, leading to potential tax and National Insurance savings for both the employee and the employer.

The primary advantage of this type of private pension contribution is the potential for higher take-home pay, resulting from lower National Insurance contributions, as well as the increased tax efficiency of pension savings.

Now let’s go through how the tax benefits a SIPP can provide:

Tax Relief on Contributions

Because you exchange a portion of your Assignment Rate for pension contributions, you are more tax efficient because the pension is paid over to your chosen provider as a Gross Employer contribution, so no tax is deducted from this amount.

In terms of overall savings, here is what you can expect:

  • Employment costs: This includes 13.8% Employer NI and 0.5% Apprentice Levy.
  • Employee PAYE Tax: 20% for income within the basic rate tax band and 40% for higher rate earners.
  • Employee NI: 12% for income within the relevant banding and 2% for income beyond that.

Keeping Your Personal Allowance

The personal allowance (currently £12,570) starts to reduce by £1 for every £2 you earn over £100,000. This means the effective tax rate on your income between £100,000 and £125,000 is a whopping 60%!

So, to retain your personal allowance, you need to reduce your taxable income to below £100,000. Paying any pre-tax income over the £100K threshold into a SIPP is a perfect way to do that, as it offers multiple benefits.

Example:

If you earn £125,140 and contribute £25,140 to your SIPP:

  • Your taxable income reduces to £100,000.
  • You retain your full personal allowance of £12,570.
  • You avoid the 60% tax trap on the income between £100,000 and £125,140.

Additional Benefits of a SIPP

SIPPs don’t just offer tax relief—they also come with other advantages:

  • Tax-Free Growth: Investments within a SIPP grow free from UK income tax and capital gains tax, ensuring your retirement savings grow efficiently.
  • Tax-Free Lump Sum: At retirement (from age 55, rising to 57 in 2028), you can take 25% of your SIPP savings as a tax-free lump sum.
  • Inheritance Tax Planning: SIPPs are often exempt from inheritance tax, making them an effective tool for passing on wealth.

If you are interested in setting up private pension contributions, please visit our other knowledge base articles to learn how to do so.

Tags: