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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.

Basic tax relief is normally applied automatically in one of two ways:

  1. If your employer takes pension contributions out of your pay:
    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
  2. You pay into a private pension scheme (any pension not held through a workplace scheme):
    The pension provider reclaims basic rate (20%) tax relief for you. After you make a contribution. the amount is added automatically on your behalf, usually the following month.

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

If your next £1 in income would be taxed at 40%:

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

This means every £100 in your pension will effectively only cost you £60 from your net salary.

If you're an additional rate taxpayer

If your next £1 in income would be taxed at 45%,

  • you receive 20% basic rate tax relief automatically, and
  • you can reclaim the additional 25% through your self-assessment tax return, as above.

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.

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
  • £40,000, the annual contribution limit.

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 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: 05 April 2016

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