Your tax allowances are shrinking – how to use your pension to lower your tax and grow wealth

The number of UK income taxpayers has rocketed from 31.5 million in 2019/20 to 37.7 million in 2024/25 – up 6.2 million in just five years.

The driving force?

Frozen income tax thresholds, quietly pulling more people into higher tax brackets.

But there’s a way to pay less income tax than you need to – making the most of your pension.

Here’s how the power of a pension can help you keep more of what you earn, save tax today, and build a stronger future.

This article isn’t personal advice. If you’re not sure whether an investment is right for you, ask for financial advice. Investments and any income from them will rise and fall in value, so you could get back less than you put in.

Pension and tax rules can change, and benefits depend on your circumstances. Tax rates and bands are different for Scottish taxpayers.

Why are we paying more UK income tax?

If you’ve received a promotion, or even a modest pay rise in recent years, you might have unknowingly slipped into a higher rate tax bracket.

The personal allowance – the amount you can earn before paying tax – has been locked at £12,570 since 2021/22.

If it had risen in line with inflation, it would now sit at £15,520.

Likewise, the threshold for higher-rate tax (40%) remains at £50,270, but if it were inflation adjusted it would be around £62,060.

The result?

More people are being dragged into higher tax bands and paying tax on a larger portion of their income.

It’s a silent squeeze affecting millions right across the income spectrum – and it doesn’t stop there.

Higher tax brackets can also trigger higher taxes on savings and some investments. And with the freeze set to continue until 2028, it’s only going to get worse.

How you keep more of what you earn

Paying into your pension, like the HL Self-Invested Personal Pension, can lower your total taxable income, helping you stay under key thresholds, while putting more money in the pocket of retired you.

Less tax now and more money later – a rare double win.

You can pay up to your earnings (or £3,600, if lower) into a pension and receive tax relief, although this is limited by the annual allowance which is £60,000 for most people.

You can normally access your pension from age 55 (rising to 57 in 2028) when 25% can be taken tax-free and the rest taxed as income.

Take Max who earns £60,000 a year – he’s classed as a higher-rate taxpayer. But if he contributes at least £9,730 to his pension this year, with a net payment (income after tax) of £7,784, he can lower his total taxable income to £50,270, keeping him within the basic-rate tax band.

Thanks to tax relief, the real cost of Max’s £9,730 contribution is much lower – costing just £5,838 due to £1,946 basic-rate tax (20%) top-up from the government.

Plus, as a 40% taxpayer for the income above £50,270, Max can claim a further £1,946 via his tax return.

Just remember, you can’t claim more higher-rate tax relief than the tax you’ve paid at that rate.

Max paying into a workplace pension each month would help lower his total taxable income in the same way.

If his employer uses salary sacrifice, the tax benefits are even greater. That’s because contributions are taken from your pay before income tax and National Insurance, meaning you save on both.

That’s an extra 8% saving for basic-rate taxpayers and 2% for higher-rate taxpayers.

On top of that, higher-rate taxpayers don’t have to lift a finger, there’s no additional 20% or 25% tax relief to reclaim from HMRC because the benefit is applied upfront.

Escaping the 60% tax trap

If you earn between £100,000-£125,140, you could be in the most punishing, but lesser-known, tax bracket of all.

There’s an effective tax rate of 60% that applies to every £1 in this bracket. That’s because for every £2 of income over £100,000, you lose £1 of your tax-free personal allowance.

Paying into your pension can turn this costly tax trap into a savvy financial gain – helping you recover your personal allowance, while also benefitting from 40% tax relief on the money paid into your pension.

The retirement reality check

Despite the clear tax perks, we’re still not saving enough for retirement. Just one in three people feel confident they’ll be able to afford to retire.

Many of us are paying into workplace pension without really stopping to ask the crucial question – am I paying in enough to achieve the life I want later on?

There’s real value in reviewing your pension strategy now – take the time to crunch the numbers. How much you need in retirement depends on the kind of lifestyle you want, but a good guide to aim for is a retirement income that’s 50%-86% of your salary.

Keep in mind that your income target might shift over time, as your pay changes, so check-ins are essential.

A pension calculator can give you a clearer view of where you’re at and where you need to be.

What can you do? – 5 smart pension moves to make now

The tax squeeze isn’t going away. But your pension gives you an opportunity to hand over less money to the taxman, while building a better future.

Have you slipped into a higher tax bracket without noticing? Check your payslip, review your take code and understand your taxable income.

How much are you paying into your pension? Is it enough to keep you in a lower tax bracket? Even small increases can help lower your taxable income.

If you’re in a workplace scheme, check to see if your employer will boost what they pay in, if you uplift your contribution. Don’t leave free money on the table.

If you’re a higher-rate taxpayer paying into your pension from your net income, don’t forget to claim the extra 20%-25% via your tax return.

As your salary grows you might need to adjust your strategy. A great habit to get into raising your contribution with each pay rise – for example, if you get a 3% rise, put 1% into your pension.