Tax Advice

What is pension tax relief and how can you claim it?

26 Jan 2022

Saving for a pension might seem a relative luxury when you’re facing other financial challenges, but the tax advantages may prove a useful benefit when you compare it with other forms of saving or expenditure.


In its simplest form, pension tax relief is a ‘top-up’ from the government on your pension contributions. The amount of top-up is based on your income tax rate. Basic rate taxpayers receive an extra £20 for every £100 they contribute and higher rate or additional rate taxpayers receive an additional £40 or £45 depending on their tax level.


The government makes this contribution by reducing the amount of actual tax you have to pay. Pension tax relief is available whether you pay into your employer’s workplace pension scheme or a personal pension scheme. 

Pension tax relief deductions 

You can obtain pension tax relief in two basic ways, depending on how your pension scheme works:

  • Pension tax relief from net pay

  • Pension tax relief at source

Pension tax relief from net pay

In this scenario, your pension contributions are deducted from your total salary before payment of income tax. Your employer or the pension scheme administrator will then claim the full amount of tax relief from HMRC at the appropriate rate. 


In practical terms, you pay less income tax and have more take home pay as well as increasing your pension fund.


This arrangement applies to workplace pensions and it means that you don’t have to make any claims yourself. Your employer or the scheme administrator does the work for you.

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Pension tax relief at source

Some workplace pension schemes and all personal pension schemes use this form of tax relief. The scheme administrator claims the appropriate tax relief from HMRC on your behalf and adds it to your pension fund. 


If you are a basic rate taxpayer and your employer adopts this method, the employer will deduct only 80 percent of your pension contribution from your salary. 


Higher rate or additional rate taxpayers can receive 20 percent of their tax relief at source, but must claim the balance of 20 or 25 percent relief by completing a self-assessment tax return. The relief will be used by HMRC to reduce your income tax liability for the tax year rather than paid into your pension fund. 

Eligibility for pension tax relief 

Any income taxpayer is eligible for pension tax relief at their appropriate tax rate. However, the situation is more complicated for low-income earners or people who aren’t liable to income tax.

Employees earning less than the annual Personal Allowance don’t pay tax. If your employer operates a workplace pension scheme and uses the net pay tax relief method, you won’t receive any tax relief on your contributions. 


The government recognises the problem and is considering changes from the 2024/2025 tax year that will allow tax relief in that situation.


However, if your employer operates the tax relief at source method, you will receive the 20 percent top-up, even though you are not liable to pay income tax. 

Limits on contributions 

The government sets a Pensions Annual Allowance. This is the total of personal contributions you can make while receiving pension tax relief. Currently the allowance is £40,000 per year. 


However, the contributions eligible for pension tax relief must not exceed your earnings for the relevant tax year. So, if you earn £30,000 and contribute £32,000 to your pension fund, you would only receive tax relief on contributions of £30,000. 


In theory, this means that you could contribute most or all of your earnings up to £40,000, if you could afford to. Any additional contributions you make would be subject to income tax at your appropriate rate. 


This limit applies to the majority of income tax payers. However, anyone earning less than £3,600 can only contribute a maximum of £3,600. 


In addition to a Pensions Annual Allowance, the government sets a lifetime allowance on pension contributions of £1.073 million. If you exceed this limit, your additional pension will be taxed at 25 percent or at 55 percent if you take the additional amount as a lump sum.

Rolling over contributions 

Although the Pensions Annual Allowance is £40,000 per year, you can carry forward any unused allowance for up to three years.  In a simple example, if you have unused relief on contributions of £10,000, your allowance for the following year would be £50,000. 

Age limits on contributions 

You can make contributions to a pension fund up to the age of 75 and receive pension tax relief. Any contributions beyond that age will not be eligible for relief.


However, if you start withdrawing money from your pension fund after the qualifying age of 55, you may be subject to the Money Purchase Annual Allowance, which can reduce the amount of pension tax relief you receive.  


This can reduce your annual pension tax relief allowance to £4000 with any additional contributions subject to income tax. The aim is to prevent people withdrawing money from their pension fund and repaying it into their current fund or a different one to obtain additional tax relief.

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Support from Accounts and Legal

Pension tax relief can be a very effective way of reducing your income tax bill and increasing the value of your pension fund. However, like most forms of savings or tax planning, it requires careful consideration and you may find it useful to take professional advice


Our team of tax advisers at Accounts and Legal can provide useful advice and help you put together the most suitable approach for your personal circumstances. 


To find out more, please contact us on 0207 043 4000 or info@accountsandlegal.co.uk. If you need help with your accounting, you can also get a quick, no-obligation quote for our services here

Read More: Planning your pension as a business owner

Keir Wright-Whyte

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Managing Director

0207 043 4000

About the author

Originally graduating with a degree in geography from Edinburgh University, Keir claims that he was then tricked into becoming an accountant by one of the UK's top 5 accountancy practices.The deception extended to the usual training in audit and associated activities.

Keir subsequently worked in a number of advisory roles with clients including in the energy trading, pharmaceuticals and financial services sectors.

He loves working at Accounts & Legal because of the variety of work and clients, the excellent team ethos and morale, the importance placed on genuinely helping and being useful for clients and because he believes what he does matters to clients and helps the firm.

Keir's primary role is to ensure that new clients with complex businesses or needs are on-boarded in the best way and he is a "trouble shooter" both for clients and where complex issues arise internally. He also helps the accounting teams strive to improve what we do for clients, whether processes or services.

When not debiting or crediting, Keir has a penchant for fixing old buildings, skiing, surfing and cycling.

  

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