#11 - Pension Tax Break Explained
Why the pension tax break is some of the easiest money you'll ever make
Here are three things I’ll bet most people are interested in - improving your long-term financial security, making the best return you can on your money, and paying as little tax as possible. Pension savings can accomplish all three…
A pension is simply a mechanism to save for the future (see our previous articles on How Pensions Work, Types of Pensions and How Pensions Grow for more). Because everyone recognises that this is sensible, the Government tries to encourage the habit by letting you avoid some income tax when you save via a pension. More bluntly - your savings are subsidised. This is one of the easiest ways to reduce your tax significantly, and it’s remarkable how many people don’t even know it exists. Here’s how it works:
Decide how much you want to save1 in your pension.
This amount is subtracted from your income BEFORE calculating your tax.
Your tax is calculated on the lower income, so you’ll pay less - often a lot less.
For example, if you’re in the higher income tax band (income above €35,300), saving €10 will only ‘cost’ you €6. Or think of it this way - €4 will be added for free to the €6 you’ve sacrificed from your take home pay. Thats a 66% return!
Here’s a better example. John saves €100 per month in the bank. He starts a pension that reduces his monthly take-home pay by the same €100 he’s used to saving, so he doesn’t notice the difference. After a year he will have €2,000 in his pension fund instead of the €1,200 he would have saved in the bank. The extra €800 is the tax he would have paid, but it now goes into his pension fund instead of going to Revenue.
And if your employer offers matching pension contributions (and many do), all of these calculations become even more favourable for you.
The only downside is that pension savings aren’t accessible in the same way that other savings are. The funds are still there, and they’re still yours, but you can’t just dip into them if you want a new car or a house deposit (though there are some limited exceptions). Hence it’s wise to always keep enough savings available for foreseeable expenses, even if pensions are usually a smart choice for the very long term.
Remember also that your pension fund can grow tax-free over time in a way that regular savings or investments can’t, and that can make a HUGE difference. Read our post on Compounding to understand how.
That’s all there is to it - pension savings aren’t glamorous but they’re an excellent way to improve your financial future while reducing your tax bill today. If any of this is new to you, a good first step is to see exactly how much tax you could save. I’ve built a simple calculator here to show you.
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There are certain limits, but if you’re just starting off you’re unlikely to need to worry about them.
#11 - Pension Tax Break Explained
I am 28 and have 14000 in my pension pot as I have employer matching at 10% that I have maxed out for the last while. The total contribution is therefore 20%. I am just now reading the small print which says max contribution for under 30 is 15% but I'm not clear on what impact that's having on the additional 5% I've been contributing?
But don't I pay tax on my state pension when the time comes because I have a private pension?