Boost your income by thousands of pounds using a simple trick allowed under new pension rules

Millions of workers coming up to retirement could boost their income by thousands of pounds using a simple trick allowed under new pension rules.

In some cases, this little ruse could boost your take-home earnings by 41 per cent - a perk normally reserved for the super-rich.

So, how does it work? Quite simply, it involves putting every spare penny you earn into a pension — particularly for those who have paid off their mortgage and no longer have children to provide for.

You could even use your cash savings, as the perk you’d get would far outweigh any interest the High Street can pay.

It might mean a year of living frugally, but it could well be worth it for any of the 3.5 million baby-boomers hitting retirement age in the next five years.

Normally, a basic-rate taxpayer would pay £200 tax on every £1,000 earned. A higher rate taxpayer would pay £400.

But instead of putting the remaining £800 (or £600 for a higher-rate taxpayer) into a bank account, if you put it into a pension you’d get all the tax back.

So, if you paid in £800, then you’d get £1,000 in your pension if you’re a basic- rate taxpayer.

All you do then is take it out a year later, or whenever you retire. The perk comes because under new pension rules, you’ll be able to make each withdrawal with a quarter tax-free. So, only £750 of every £1,000 is taxable.

A basic-rate taxpayer would then pay £150 tax on the remaining £750. In total, they would have £850. That’s an extra £50 income for every £1,000 invested, compared with if they had simply pocketed the money initially.

A higher-rate taxpayer would pay £300 tax on the £750 taxable amount, giving them a total of £700. That’s an extra £100 on every £1,000.

But there is a further boost for those who are higher-rate taxpayers when they are working and become basic-rate taxpayers when they retire.

All you’ve really done is deferred taking your income for a year or two. But by doing so, you’ll get £850 for every £1,000 you earned rather than the £600 if you took it now. That’s an extra 41 per cent income.

This has become possible only since the pension rule changes. Previously, most people would have been forced to buy an annuity with the taxable sum.

But new modern pensions known as self-invested pension plans (Sipps) will allow you to take out the money almost instantly.

For this to work, it will need to be one of these types of pensions with very low or no charges, as older insurance-style schemes and many employer schemes won’t let you have the money so easily.

We’re not suggesting you invest the money or splash it on the stock market. You just need to put it into a Sipp and leave it sitting in cash.

Then, when you retire a year or two later, take it out again. Suitable Sipps include those run by Hargreaves Lansdown and Fidelity Personal Investing.

Hargreaves would make no charge if the money was held in cash, but there would be a £250 charge if it was not left for at least a year. With added interest, a basic-rate taxpayer could walk away with £851.40 after a year and a day.

Looking forward: New modern pensions known as self-invested pension plans (Sipps) will allow you to take out the money almost instantly

Fidelity Personal Investing has a 0.35 per cent basic annual charge, but this is effectively cancelled out by the 0.35 per cent interest it pays on cash. It makes no charge on withdrawals. Many others have much higher administration charges, which would undermine the tax benefits.

For example, Barclays Stock- brokers charges £186 a year including VAT; Charles Stanley £120 a year including VAT.

Others have charges for administration, income payments or setting up the Sipp.

You can put £40,000 a year including the tax relief into your pension. You may not feel that you can sacrifice so much from your pay packet, but you are allowed to use money in your savings account, too — and that is currently earning a pittance.

The £50 boost you get as a basic-rate taxpayer is equivalent to 6.25 per cent interest.

For people who are higher-rate taxpayers now, but will drop to basic rate on retirement, it’s more complicated, but it’s the equivalent of earning 41 per cent interest.

There are some key things to remember. Any income you take from this Sipp will be added to your other income to decide how much tax you must pay that year.

If you’re very close to becoming a higher-rate taxpayer, it could tip you into the 40 per cent bracket.

Therefore, you may need to spread it over a few years to avoid paying higher-rate tax. When it comes to contributing, you must have paid the tax to get tax relief.

Those who don’t pay tax can contribute up to £2,880-a-year and receive a top-up to create a pension of £3,600. This can be useful for non-working spouses.

One key group should not do this because it would leave them worse off: those who expect to be higher-rate taxpayers when they retire, but currently pay basic-rate tax.

This may be the case with people who were in highly paid jobs, but are easing towards retirement in lower-paid or part-time positions.

Culled from: Daily Mail