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Martin Lewis explains 'really important' tax rule when you pay into your pension

You could have more in your pension pot than you think

[Martin Lewis on his ITV show]

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Martin Lewis has explained some key rules around pensions(Image: ITV)

Martin Lewis has urged people to understand what he calls a 'superpower' around how pensions work. He shared several tips about pensions on his BBC podcast, to help people get to grips with how these retirement pots work.

One point he had huge emphasis on is understanding how tax relief on your pension contributions works. He said this is a vital principle to know as it is "the big pension superpower". He explained: "It is a savings pot, but it's tax-efficient because when you put money into your pension, it comes from your pre-tax income. This is really important."

He shared some figures to show how this works. Normally you pay income tax on your income, so if a basic rate taxpayer earning 100 would have 20 taken away in tax. But if you put 100, the whole amount goes in.

'You're 40 up'

Mr Lewis said: "If you put it towards your pension, the entire 100 goes towards your pension. So, you're effectively that 20 up. If you're a higher-rate taxpayer, normally for every 100 you're paid, 60 would be in your pay packet, but you can put the whole 100, so you're 40 up."

He also explained another way you could be getting more than you think paid into your pension - as your employer is obliged to top it up. Mr Lewis told his listeners: "Plus, if it's a workplace pension, then most people are auto-enrolled into the pension scheme, and that means not only do you get the tax benefit, but your employer has to contribute too.

"The minimum amount is: you are putting in 5 per cent of your income, it has to give you 3 per cent on top, so you'd have an 8 per cent contribution. And all of that goes into this investment vehicle, if you like."

The rules state that a minimum 8 per cent of the employee's salary has to go in. This can be divided as you choose between a contribution from the employee and an amount from the employer. Either side can also pay in more to have a higher overall contribution.

How do your pensions grow?

It's worth understanding how your pension pot grows over time. Mr Lewis pointed out that your pension is not just sitting in a standard bank accountit is actively working for you in the stock market.

The money expert said: "The thing to understand about the pension itself, the pension pot, you can choose to have it in a whole different range of investments. You can go really sophisticated and be picking your own investments, and you could do single shares, although that's high risk, inside something like a SIPP, a self-invested personal pension.

"Or you could go to a sort of a robo-investment firm where you just say, 'I want medium risk,' and it will pick a whole load of shares for you in a broad spread of investments to try and ride out the market. It is just an investment fund."

You can draw down from your private pension from the age of 55. This access age is increasing to 57 from April 2028.

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