The vast majority of people who pay into a UK pension scheme are eligible for tax relief. Given that pension contributions have more than tripled since the introduction of auto-enrolment in 2012, this is overwhelmingly positive news.
When you pay into a pension scheme, the government adds tax relief up to the value of your annual allowance, effectively boosting the amount you save. However, some exceptions may apply, such as those with no taxable income, non-UK residents, those aged 75+ and high earners.
There are two methods by which tax relief is paid on your pension contributions, depending on the type of pension scheme you have. In this article, we will focus on the most common way, ‘relief at source’, before touching briefly on the other method, ‘net pay arrangement’.
How does pension tax relief work?
One of the biggest advantages of saving into a pension is that your contributions can benefit from pension tax relief. This is given in the form of a contribution and is to encourage you to save for retirement in order to relieve the burden on the state pension pot. It is essentially free money and acts as a bonus to your pension contribution.
Your pension scheme provider will claim tax relief at the highest rate of income tax that you pay. If you are a Basic Rate taxpayer, this means you will get 20% tax relief. If you are a Higher Rate taxpayer or an Additional Rate taxpayer, it gets even better. Tax relief will be paid at 40% and 45%, respectively.
To illustrate how effective and tax-efficient pension contributions can be, take a look at this chart showing the effect of tax relief on a £100 pension contribution:
This means that for a Higher Rate taxpayer, they only need to pay £60 to make a £100 contribution.
Why is it important?
For Basic Rate taxpayers, if you make a £1 pension contribution, this automatically becomes £1.25. In other words, it’s like having a 25% boost to every contribution!
If you contribute £100 to your pension, with tax relief, the contribution becomes £125!
This is one of the biggest reasons we believe pensions are one of the best savings vehicles to invest in.
When you calculate the benefit using larger pension contributions, you can see just how powerful this becomes. For example, if a Basic Rate taxpayer made a net pension contribution of £10k, they would receive £2,500 pension tax relief, taking their contribution up to £12,500.
How are Basic Rate and Higher Rate tax relief paid?
If you are a Basic Rate taxpayer, your pension scheme will receive tax relief automatically from HRMC.
If you’re a higher earner, it gets even better, and you will receive 40% tax relief. 20% is added to your contribution automatically by your pension provider, and you can claim the remaining 20%/25% back on your self-assessment tax return.
Higher rate tax relief is quite a contentious issue, and many think tanks believe it’s unfair that higher earners get more tax relief than lower earners, arguing that a flat rate of tax relief would be fairer.
When the budget is announced each year, there is always speculation around whether it will be scrapped, although successive chancellors have rejected this – so far. So, there’s good reason for Higher or Additional Rate taxpayers to maximise their pension contributions sooner rather than later.
Who is eligible for pension tax relief?
Tax relief on pension contributions is only given if you meet the following criteria:
- You are under the age of 75
- You are a UK resident
Tax relief is granted up to the value of your pension annual allowance, which is the lower of £60,000 or your qualifying earnings. For a more detailed explanation of how to calculate your annual allowance, please read our article on pension contributions here.
It is very important to think about your pension savings in net and gross terms.
A gross pension contribution is after tax relief is added to personal contributions.
Tom is a Basic Rate taxpayer, and his salary and annual allowance is £30,000. Tom wants to maximise his annual allowance, so he needs to make a £24,000 pension contribution.
To calculate the net amount, simply take the gross contribution of £30,000 and multiply it by 0.8. This is because tax relief is awarded on the total gross contribution.
Can I get tax relief if I have no earnings?
If you have no relevant earnings or you are retired, it is possible to make a pension contribution and benefit from tax relief. You can make a pension contribution of £2,880, and it will be grossed up to £3,600. This is £720 tax relief or ‘free money’ and is often overlooked.
Also, if you have taken flexible benefits from your pension scheme, then you will have triggered what’s known as the ‘money purchase annual allowance’. This means the maximum you can pay into your pension would be the lower of £10,000 or your relevant earnings.
How do you receive tax relief if you are in a ‘net pay arrangement’?
Many workplace pension schemes utilise the net pay arrangement, such as Defined Benefit pensions. However, if your workplace pension is a ‘Master Trust’, then your pension scheme may operate a net pay arrangement.
If you are in a net pay scheme, then your pension contributions are automatically deducted from your salary, and no income tax or National Insurance contributions are paid on the contribution amount.
This means you get income tax relief back immediately at the highest rate of income tax that you pay. So if you are a Higher Rate taxpayer or above, this means you do not have to claim the extra tax relief back on your self-assessment tax return.
However, if you are a non-taxpayer and earn below the personal allowance (£12,570 for the 2023/24 tax year), you will not get any tax relief. This is one of the reasons why a net pay arrangement can be viewed as unfair. If you are in a relief-at-source scheme, this doesn’t matter, and you will still get the tax relief.
How can pension contributions reduce your Income Tax?
Pension contributions can be very tax-efficient if your income or bonus pushes you into a higher tax band. For example, if your salary is £55,270, you are a Higher Rate taxpayer.
You could make a gross pension contribution of £5,000 (£4,000 without tax relief), and this would have the effect of extending your income tax bands, meaning you would avoid paying Higher Rate income tax.
Income tax bands and rates 2023/24
|Band||Taxable Income||Tax Rate|
|Personal allowance||Up to £12,570||0%|
|Basic rate||£12,571 to £50,270||20%|
|Higher rate||£50,271 to £125,140||40%|
|Additional rate||Over £125,140||45%|
This becomes more important if your income is above £100,000 as your personal allowance is reduced by £1 for every £2 of income over this threshold. This is often referred to as the ‘60% tax trap‘.
Therefore, pension contributions can be a very tax-efficient way of artificially reducing your income and, subsequently, how much income tax you pay.
How much tax relief can I get on pension contributions?
The amount of tax relief you receive depends on your marginal rate of income tax, i.e. 20%, 40% or 45%.
Your pension provider will automatically claim Basic Rate relief, and if you pay tax at the Higher or Additional Rate, you can claim the additional tax relief back on your annual tax return.
The maximum amount of tax relief that can be awarded to your pension contributions is the lower of £60,000 or your relevant earnings.
Contact us for advice on pensions tax relief
Heritage Financial Planning is here to answer all of your questions about pension saving and claiming tax relief.