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Tax relief on pension contributions

Updated 03 September 2020

3min read

Nick Green
Financial Journalist

One of the biggest advantages of pension saving is that you can pay into a pension to reduce tax. All the money you pay into a pension qualifies for tax relief, which provides an instant boost to your savings and helps the fund to grow faster than other kinds of investment.

What is pension tax relief?

To encourage saving for retirement, the government pays tax relief on pension contributions. This means that your pension provider can claim tax back from HMRC and add that amount to each contribution you make. From your point of view, it’s like receiving a bonus on everything you save.

Tax relief - how is it calculated?

You’ll receive tax relief at the highest rate of income tax that you pay. If you’re a basic rate taxpayer, you’ll get 20 per cent tax relief. This means that every pound you pay in becomes £1.25 (because £1.25 taxed at 20 per cent would become £1).

In other words, receiving 20 per cent tax relief is the equivalent of having a 25 per cent boost to every contribution you make into your pension. This is one of the biggest reasons why pensions are so hard to beat as an investment.

Tax relief on pension contributions for high earners

If you’re a higher-rate taxpayer, you’ll get 40 per cent. This means that every pound becomes around £1.66 – the equivalent of a 66 per cent boost. Additional rate taxpayers get 45 per cent tax relief (effectively around an 80 per cent boost!).

However, this additional tax relief isn’t delivered automatically. The basic 20 per cent tax relief will be added to each contribution, but if you’re a higher or additional rate taxpayer you’ll have to claim back your extra tax relief via your tax return. See our self-assessment tips for guidance on how to do this, and talk to your financial adviser or accountant for more information.

What if I don’t have an income at the moment?

If you’re not currently working, or earning below £3,600, you can still contribute to a pension and get tax relief (such as by transferring savings, or having your partner contribute on your behalf). However, you’ll only receive tax relief on contributions up to £3,600. You can pay in more if you wish, but this additional amount will not receive tax relief.

Do pension contributions reduce your taxable income?

The answer to this is both yes and no. Pension contributions are free of income tax, which means you are refunded the income tax that you initially paid on this money. In that sense, the answer is yes.

But does making pension contributions actually reduce your taxable income for the purposes of income tax bands? Well, if you are making pension contributions out of your earnings, the answer is no. If you earn over £50,000 a year you will be considered a higher rate income tax payer, though you can claim back higher-rate tax relief on pension contributions above that threshold.

However, there is a way to actually reduce your taxable income with pension contributions. You can do this using a salary sacrifice scheme. In this kind of scheme, your employer agrees to make additional pension contributions on your behalf in exchange for reducing your salary by a certain amount. This saves on National Insurance contributions, so you can potentially get a higher pension contribution than you could have afforded yourself from your salary. It can also have the effect of reducing your salary to a lower tax band. Ask your employer if they offer a salary sacrifice scheme.

How much can I pay into a pension?

It’s important to know how much you can pay into a pension and still receive tax relief. There is a cap on how much you can contribute to a pension in a single year, and also a limit to the total size of all your pension pots over a lifetime. If you exceed these limits, you’ll have to pay additional tax charges. Find out about your annual and lifetime allowances.

Why is pension tax relief so important?

Tax relief on pension contributions is a real help when it comes to saving for retirement. Quite simply, the more you pay in (and the more your employer pays in) the more you receive back from the government. At the same time, it’s crucial to understand your allowances and limits, so that you don’t contribute too much and end up paying tax charges.

Whatever your situation, talk to a financial adviser to make sure you’re benefitting as much as possible from pension tax relief.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.