06 September 2022

Understanding pension tax relief

3 min read

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If you don’t quite get pension tax relief, you’re not alone, but it pays to make the most of it.

The government encourages pension saving by giving tax incentives, making tax relief one of the major benefits of saving into a pension.

How does it work?

If you’re a basic rate taxpayer you can essentially contribute £100 into your pension for just £80. This means when you pay into your pension from your pay packet or make a single contribution, you’ll get a boost from the government in the form of tax relief.

And the more you pay into your pension, the more help you’ll get.

For example, if you pay basic rate tax:

You pay Tax relief added as a boost to your contribution Total contribution added to your pension plan
£80 £20 £100
£160 £40 £200
£240 £60 £300

 

Higher or additional rate taxpayers

If you pay a higher or additional rate of income tax you could benefit from additional tax relief. If you’re in a workplace scheme and your employer takes your pension contribution before you pay tax, then you won’t need to do anything.  But if you pay into an individual pension or a workplace pension and your contribution is taken after tax has been paid then you’ll need to claim the difference between basic-rate tax and the amount of tax you pay from HM Revenue & Customs (HMRC).

Tax relief can change and depends on your individual circumstances and where you live in the UK.

Limits on tax relief and how much you can contribute

There’s no limit on how much you can save into your pensions each tax year. But there are limits on how much tax relief will apply.

This is 100% of your earnings on contributions you make. So if you earn £20,000, then your limit would be £20,000.  If you don’t have any earnings the most you can pay into a pension is £2,880. Then tax relief is added to make a total of £3,600.

The annual allowance and the lifetime allowance

There's a limit to how much you can pay into your pension every year without a tax charge applying. This is called the annual allowance. For the 2022/23 tax year it’s £40,000, although unused annual allowance from up to three tax years ago can be carried forward to the present tax year to boost the amount of annual allowance available.

There’s also a limit to the amount of pension savings you can build up without a tax charge applying when you come to take your pension benefits. This is called the lifetime allowance and for the 2022/23 tax year it’s £1,073,100.

These may sound like big numbers, but they don’t only apply to people on high salaries. More people are being captured by these limits. For example, people who may have had long service in a final salary scheme could find themselves reaching the limits.

There are other limits to be aware of too; the money purchase annual allowance and the tapered annual allowance. You can find out more about them in our pensions and tax - know your limits article.

Don’t miss out on the benefits of saving into a pension

If you’re getting close to the annual allowance or the lifetime allowance, it could be tempting to stop paying into your pension to avoid a tax charge. However, this might not always be the best thing to do. You could miss out on many benefits by stopping your pension contributions. This includes employer contributions that could really boost your income in retirement.

Avoiding the charges shouldn’t necessarily be your default position. You should think carefully about whether stopping contributions to avoid the charge or staying in the scheme and paying the charge will leave you better off in the long term.

People in danger of going over their annual allowance may worry about having enough money to pay the tax charge. However, there are instances where the scheme will pay the charge for you.

Seeking financial advice

Paying an annual or lifetime allowance charge is not a bad thing. It’s not a punishment or a sign that you’ve done something unlawful. It’s just a way for HMRC to claw back overpaid tax relief.

It’s a good idea to speak to an independent financial adviser if you’re in this situation before making a decision. They’ll go through your individual circumstances and advise you of the best way to proceed. Advisers may charge for their services – but they should agree any fees with you up front.

Find a financial adviser

There are a number of directories that you can use to search for financial advisers in your area and according to what services they offer.

Find out more