Tax relief on pension contributions

One of the best features of using a pension to save for retirement is tax relief. When you pay into your pension, some of the money that would have gone to the government as tax goes towards your pension instead. This can help reduce the amount of tax you pay and be used to help boost your savings for the future. 

This ‘tax relief’ is given  based on the rate of income tax that you pay.

However, depending on how your pension scheme works, if you don’t pay tax you might not get tax relief.

Equally, you might have to claim extra tax relief not claimed by your scheme.

In addition, there are certain limits that you need to be aware of which can impact the amount of tax relief you're entitled to. Exceed these limits and you may have to pay a tax charge which effectively claws back any excess tax relief given. See below for more on this.

There are two ways you can get tax relief on your pension contributions. These are known as relief at source and net pay.

If you’re in a workplace pension, your employer chooses which method is used. If you’re in a personal pension, the relief at source method is always used.  

With relief at source, your contributions receive a boost from the government. You can potentially claim more back through your tax return if you pay tax above the basic rate.

Here’s how the relief at source method works in more detail:

1. Your employer deducts tax from your taxable UK earnings as normal.
2. They then deduct your pension contribution from after-tax pay and send this to your pension provider. If you're self-employed, you would make a contribution from your taxable UK earnings directly to the pension provider.
3. Your pension provider then claims 20% in tax relief direct from the government, which they add to your pension pot. If you live in Scotland and pay tax at the Scottish starter rate of 19%, you still get tax relief on your pension contributions at 20%.

This way is better for people who don’t pay any tax as they still get tax relief. See our section on ‘Tax relief if you don’t pay tax’ below.

However, with this arrangement, people who pay higher rates of tax than 20%, whether employed or self-employed, will have to claim the extra tax relief through their tax return or direct from HMRC

With net pay, your pension contributions are made before you are taxed. You will usually therefore pay less tax because your tax will be calculated based on a lower amount of UK earnings.

Here’s how the net pay method works in more detail:

1. Your employer deducts the full amount of your pension contribution from your pay before any tax is deducted.
2. You then pay tax on your UK earnings minus your pension contribution. As a result your tax bill will usually be lower.
3. Although you’ve paid the full amount of your pension contribution yourself, you get the tax relief straight away by paying less tax.

With this method, whatever rate of tax you pay, you get full tax relief without having to claim it.

However, if you don’t pay tax, this method means you won’t get any tax relief. See our section on ‘Tax relief if you don’t pay tax’ below. 

If you earn less than the Personal Allowance (£12,570 in the tax year 2023/24) and so don’t pay tax, you might or might not get tax relief if you’re in a workplace pension. It depends on which tax relief system your employer uses.

If your workplace pension uses the net pay method, the full amount of the pension contribution is taken from your pay before tax is deducted.

Instead of getting tax relief added to the pension contribution, you get tax relief by having a lower tax bill.

But if you don’t pay tax, there’s no tax bill – so you don’t benefit from tax relief on your pension contributions. 

To remedy this the government is proposing that for contributions made in the tax year 2024-25 onwards there will be a way to claim the tax relief on your contributions. 

Further details on how this will work are expected in 2023.

Under the relief at source method, the pension provider always claims tax relief at the basic rate (20%). They claim this from the government and add this to your pension pot.

So as long as you don’t pay in more than your relevant UK earnings, you’ll benefit from 20% in tax relief.  

The following example shows how the two methods differ: 

While both methods would put £6 into your pension, with net pay, the full £6 is taken from your pay.

You can’t claim any money back from HMRC. And you’ll have slightly less take-home pay compared with if your pension scheme used the relief at source method.

If you have no relevant UK earnings or earn less than £3,600 a year, you can still contribute to a personal pension which uses the relief at source method. And you’ll qualify to have tax relief added to your contributions up to a certain amount.

If you’re in a workplace pension, you’ll need to check the type of pension you have with your employer or pension provider.

The maximum you can contribute is £2,880 a year.

Tax relief is added to your contribution so if you contribute £2,880, £720 is claimed from the government and added to your pension. This means a total of £3,600 will be contributed into your pension scheme. 

If your employer hasn’t set up a workplace pension scheme yet, ask them to consider a scheme that operates a relief at source arrangement.

However, if the scheme is already in place, your options are limited. This is because your employer must operate the same method for all staff in the scheme.

Don’t be tempted to leave the scheme to set up one of your own as you’ll lose any contributions that your employer makes. This will be more than the tax relief you’ve lost.

You could ask your employer if they would be prepared to top up your scheme by the tax relief figure or pay into another pension scheme which will give you tax relief, but they don’t have to do this. 

The simplest way is to check your scheme booklet if you can locate it. Alternatively, you can ask your HR department (or whoever does the payroll for your employer) if you're employed or you can check with the pension provider.

Ask whether the scheme is operated using:

• the net pay method – full pension contribution taken from pre-tax pay, or
• the relief at source method – lower pension contribution taken from after-tax pay and tax relief claimed from government by your pension provider.

There is no limit on the amount that can be saved into your pensions each tax year. There are limits on the amount that can be saved towards a pension each year with tax relief applying and before a tax charge might apply.

Firstly, any contributions made by you or someone else on your behalf must be equal to or less than your relevant UK earnings for the tax year in which they are made.

• For example, if you earn £20,000 but put £25,000 into your pension pot (perhaps by topping up earnings with some savings) – you’ll only be entitled to tax relief on £20,000.
• Similarly, if you earn £80,000 and want to put that amount in your pension in a single tax year, you’ll normally only be entitled to tax relief on £60,000.

This condition does not apply to contributions made into your pensions by an employer.

The second limit you need to be aware of is the annual allowance.

If the total amount saved towards a pension in a given tax year is more than the annual allowance, then you may have to pay a tax charge which effectively claws back any excess tax relief given.

The annual allowance is £60,000 for most people; however, some people have a lower annual allowance.

How your pension savings are measured against the annual allowance depends on the type of pension scheme: defined contribution or defined benefit. 

The tapered annual allowance further limits the amount of tax relief high earners can claim on their pension savings by reducing their annual allowance to as low as £10,000. This reduced allowance could change from tax year to tax year depending on your income.

Plus, if you begin taking flexible retirement income from a pension pot you’ve built up, your allowance might also be reduced to £10,000 in this and future tax years for contributions to defined contribution pensions.

This is known as the money purchase annual allowance. 

It is also possible to use unused allowance from up to the previous three tax years to receive tax relief on higher contributions. 

This is known as ‘carry forward’ and conditions apply.

Tax relief is only available on relevant UK earnings up to the age of 75. Contributions made to a pension after age 75 are not eligible for tax relief. 

Relevant UK earnings are the type of earnings that attract tax relief and include:

• income from employment (for example salary, wages, bonus, over time or commission)
• any redundancy payment above the £30,000 tax exempt threshold
• benefits in kind which are taxable
• profit-related pay (including the part which is not taxable)
• income from a trade, profession or vocation conducted individually or as a partner personally acting in a partnership
• rental income from UK or EEA furnished holiday lettings businesses
• patent income.

This list is not exhaustive.

A salary sacrifice arrangement is an agreement between you and your employer.

It involves you giving up a part of your salary in return for your employer making a contribution to your pension.

If you’ve agreed this with your employer, the whole contribution is treated as coming from your employer. This means you don’t get any tax relief as such.

However, by essentially giving up a portion of your salary, the amount you get paid is reduced. This decreases the amount of Income Tax and National Insurance you pay.

This will usually mean your take home pay is higher.

The National Insurance contributions your employer makes will be reduced, too.

Some employers will pass some or all of this National Insurance saving onto you. This, again, increases the contribution going into your pension.

If you’ve set up your own pension, the contributions you make into the scheme are usually treated as coming from your after-tax pay.  

Your pension provider will claim back basic rate tax at 20% from HMRC, and add this to your pension pot. This gives you tax relief.

This means that if you contribute £80, your pension provider will claim back £20. So a total contribution of £100 goes into your pension pot. 

If you’re a higher rate taxpayer, you can claim further tax relief (at your higher rate) from HMRC.

This is usually claimed through your self-assessment tax return. Or you can contact HMRC direct if you don’t usually complete a tax return.

This means that if you pay income tax at 40%, you could claim an extra £20 tax relief. This makes the cost of a £100 contribution into your pension £60 to you – £20 claimed by your pension provider and £20 reclaimed by you. 

Depending on the type of pension you have, it might or might not be possible.

Check with your employer and/or the pension provider – they’ll be able to confirm if this is an option and how the tax relief works.

If you’re in a workplace pension that uses the net pay method (see our ‘How tax relief works’ section above), it might not be possible.

Are you in a personal pension that you’ve set up yourself or your employer has set up? Are they in a personal pension that they’ve set up by themselves or that their employer has set up? Then if someone else (apart from your employer) pays into your pension (if the pension provider allows this), the contribution is treated as if you made it. So the pension provider will claim and add the tax relief to your pension pot.

Plus, you can claim higher rate relief if you’re a higher rate taxpayer.

However, you’ll still need to have enough relevant UK earnings to cover the amount of the contribution, or you won’t get the tax relief for any contributions above £3,600 a year.  

Are you contributing to a retirement annuity contract that you started before 6 April 1988? Then the pension provider doesn’t usually claim and add any tax relief to your pension pot.

This means you need to claim any tax relief you’re due – both basic rate and any higher rate relief – from HMRC.

You can do this by contacting HMRC or through your tax return.

There’s no limit to the amount you can build up in pensions.

The lifetime allowance limit of £1,073,100 that existed until the 2023/24 tax year is set to be abolished in April 2024. For 2023/24, the excess charge will be reduced to 0% until appropriate legislation can be put in place.

PCLS (Tax free Cash) will continue to be limited to 25% of £1,073,100 (£268,275) unless you hold any existing lifetime allowance protection.

All employers must now automatically enrol all eligible workers into a pension scheme.

It requires a minimum total contribution – made up of the employer’s contribution, the worker’s contribution and the tax relief.