Tax relief on pension contributions

If you’re under the age of 75 and contribute to a pension scheme then you can benefit from tax relief on your contributions. Tax relief boosts your pension pot, which helps you get a better long-term return on your investment.

How does pension tax relief work?

Tax relief on pension contributions is designed to encourage people to save for later life. This means that, within an annual limit, money you contribute to a pension is effectively free from income tax up to certain contribution limits.

Contribution limits

You will receive tax relief on gross pension contributions up to whichever is the lower of these amounts:

  • The equivalent of 100% of your annual earnings; or
  • The annual allowance. For most people the annual allowance will be £40,000.
  • High earners, those earning more than £150,000 pre-pension contributions will have a reduced annual allowance. The tapered annual allowance could be as low as £10,000.

Even if you don’t have any earnings, you can still get 20% tax relief on pension savings up to £3,600 per year.

Your annual allowance will drop to £10,000 when you take flexible benefits such as:

  • Taking cash or a short-term annuity from a drawdown fund
  • Taking an ‘uncrystallised funds pension lump sum’ (cash from your pension pot)

There is also a Lifetime Allowance currently set at £1 million. There is no tax relief on lifetime pension savings above this amount.

Tax relief is normally applied automatically in one of two ways and depends on the type of scheme that you belong to:

  1. Net pay method: Your employer takes pension contributions out of your pay before tax. The money arrives in your pension before tax is deducted.Your pension provider receives the gross amount straight away, and you don't need to reclaim any tax through your tax return. This is common for members of final salary and trust based occupational schemes.
  2. Relief at source method: Your employer pays your contributions after you have paid tax on your earnings. The pension provider reclaims basic rate (20%) tax relief for you. If you are a higher rate taxpayer you can claim additional tax relief via your self assessment. This method is usually used if you are a member of a personal pension scheme including group personal pensions and group stakeholder schemes.

Note: If you make payments into your pension via a salary sacrifice arrangement the contribution is treated as an employer contribution. Due to the reduction in salary this has the same effect as tax relief and you also benefit from reduced NI contributions.

The amount of tax relief you get depends on the level of income tax you pay.

For example, assuming you are paying into a private pension scheme:

If you are a basic rate taxpayer

When you contribute £80 to your pension, your pot will actually grow by £100. It works as follows:

  • When you earned £100, that income was taxed at basic rate (currently 20%), meaning that £20 went to HMRC and you received £80
  • When you pay £80 into your pension, the government recognises that you paid £20 in tax to receive that amount, so you actually get £100 added to your pension

If you're a higher rate taxpayer

  • you receive 20% basic rate tax relief automatically as above, and
  • you can claim the difference – up to an additional 20% – through your self-assessment tax return. The money will be returned to you as a tax refund.

The extra tax relief available depends on the total personal contributions paid and the member’s total income. You must have paid sufficient tax at the higher rate to claim the full 40% relief.

If you're an additional rate taxpayer

  • you receive 20% basic rate tax relief automatically, and
  • you can reclaim up to an additional 25% through your self-assessment tax return.

The extra tax relief available depends on the total personal contributions paid and the member’s total income. You must have paid sufficient income tax at the 45% rate to claim the full relief.

You can only claim tax relief on pension contributions worth up to 100% of your annual earnings – HMRC can ask you to pay back anything over this threshold.

Tax when you access your pension

From the age of 55, you will usually have full access to your pension funds – but you should consider the impact of tax before you act. You can withdraw up to 25% of your pot as a tax-free lump sum.

Any other income you generate from your pension pot will be subject to income tax.

Deciding what to do with your pension pot is one of the biggest financial decisions you will make, and it's important to get it right. A financial adviser can help you the tax efficiency of your retirement savings and help you choose a retirement income option to suit your needs.

Last updated: 18 April 2017