Your guide to pension tax relief

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Saving into a pension and taking advantage of tax relief can be extremely rewarding.

When you pay money into your pension the government tops it up too. This comes in the form of tax relief and it means that some of the money you’ve paid in tax goes into your pension instead. It’s money that you'll miss out on if you don’t save into a pension.

The idea is the money you pay into your pension is taxed as income when you earn it – the government simply gives you that tax back into your pension pot.

How it works

Let’s say you want to put £100 into your pension. When you earned that £100 – assuming you're a basic-rate taxpayer – you had to hand over £20 of it in income tax. So, in order to put £100 into your pension, you're only required to pay in £80, as the government will add the £20 it took in income tax to your pension.

If you're a higher rate taxpayer, you’ll get tax relief at 40% (be aware that this rate is for England, Wales and Northern Ireland, as Scotland sets its own income tax rates and thresholds). However, in this case, you may only get tax relief at the basic rate paid into your pension automatically and you may have to claim back the difference via your self-assessment tax return. Your tax relief is added to your pension savings immediately, so it can grow alongside the rest of your pot. Plus, any growth in your pension investments is tax-free. Tax relief doesn’t just help long-term retirement savings, it can also be a real bonus for anyone approaching retirement age. If you want to do some last-minute saving you can still put money into your pension and get an immediate uplift thanks to tax relief at the basic rate. While money you take from your pension is taxed as income, you can withdraw 25% of your pension savings tax-free once you're over 55, meaning a pension can be an incredibly tax-efficient savings vehicle for later life.

As with all investments, the value of your pension may fall as well as rise and you may get back less than you paid in.

Don't forget about the limits

With such generous tax benefits, there are limits on how much tax relief you can enjoy. Each year you can put the equivalent of 100% of your relevant UK earnings or £3,600, whichever is higher, into your pension and claim tax relief. If you have more than one pension the limit is the maximum you can pay into all your UK pension plans in total in any year, not the limit for each pension. When we talk about a year, we mean a tax year, which runs from 6 April one year to 5 April the following year, rather than a calendar year.

When working out how much tax relief you’re entitled to, your relevant UK earnings can include:

  • Employment income.
  • Self-employed income.
  • Certain redundancy payments (including salary in place of notice, outstanding salary payments and holiday pay).

Investment income, property rental income and pension income don’t count as relevant UK earnings. Also, if you work for yourself and have a limited company, dividend payments don’t count either.

If you move abroad and no longer have any relevant UK earnings you can contribute up to a maximum of £3,600 and still get tax relief for the five tax years after the tax year you leave the UK. These contributions must be to the pension scheme you were a member of before you left the UK. After the five tax years you won’t be entitled to any further tax relief unless you return to the UK and/or have relevant UK earnings again.

There’s another limit, called your Annual Allowance, which is £40,000 in the 2021/22 tax year (your allowance may be lower if you’ve flexibly accessed your pension pot or have a very high income). If you pay more than £40,000 a year into your pension, including any employer contributions, you’ll incur a tax charge, which is the equivalent of the tax relief you would have received on those contributions above the annual allowance.

If you earn less than the Personal Allowance, which is the amount of income you can receive in any tax year without having to pay income tax on it, you still get tax relief on pension contributions you make, up to a limit of £3,600 a year. That figure includes tax relief at the basic rate, so it would only actually cost you £2,880 a year.

Over your lifetime, if your pension pot grows to be worth more than the Lifetime Allowance, which is £1,073,100 in the 2021/22 tax year, then you'll receive no more tax relief and could have to pay a tax charge.

Tax relief after you retire

You can continue to save into a pension even after you retire, up to the age of 75, and still get tax relief. However, once you’ve taken money from your defined contribution pension, the maximum you can contribute to your pension reduces to £4,000 each year. This lower limit of £4,000 doesn’t apply if you only take out your tax-free cash or in certain other circumstances. You can find out more in our guide ‘What are the limits on tax relief?’

How tax relief is paid

If you’re paying into a workplace pension, there are two different ways that the tax relief top-up from the government can be paid. It’s useful to know which system your employer uses so you can understand how it all works.

Relief at source

Here, your employer takes tax and National Insurance from your pay, deducts 80% of the pension contributions you have agreed to make, and pays them into your pension. When the pension provider receives your contribution, it adds tax relief at the basic rate of tax (the other 20%). If you’re a higher rate taxpayer, you have to claim back the additional tax relief through your self-assessment tax return or by contacting HM Revenue and Customs (HMRC). This system is generally used for personal pensions.

Net pay arrangement

Here, your employer takes your pension contribution before you have paid tax or National Insurance. This means that you pay less tax overall, which is how you receive the tax relief. The advantage of this arrangement is that you receive tax relief at the same rate as you pay tax. So, if you’re a higher rate taxpayer, you’ll receive tax relief at the higher rate without you having to claim it from HMRC. The disadvantage is that if you earn over £10,000, but under the personal allowance, which is £12,570 in the 2021/22 tax year, you won’t receive any tax relief.

If you don’t know which type of tax relief arrangement your employer has, ask your staff pension or HR department.

With an annual limit of £40,000 each year that you could potentially pay into your pension, that means there is up to £8,000 of tax relief up for grabs annually for basic rate taxpayers – and even more for higher and additional rate taxpayers. So, it’s safe to say that saving into a pension can be very rewarding.