Since introducing the auto-enrolment workplace pension contributions in 2012, the government has ensured that a large percentage of the UK working population is savings towards their retirement.
Most of these people will be eligible for tax relief on pension contributions, where the government gives their pension savings a little top-up. It’s also available for those who are self-employed and have a private pension.
The method by which this tax relief is issued will vary depending on whether you are in a workplace pension or private pension scheme and what system is used.
Therefore, this article will explore precisely what pension tax relief is, how it works, how much you can expect to receive, and more.
Pension tax relief is when the government pays money into your pension fund as a reward for investing in your future. When you pay into your pension fund, the money that you would have paid to the government as tax is instead reinvested back into your pension by the government, hence the pension tax relief.
How much tax relief you receive is based on what Income Tax band you are in. For instance, basic rate taxpayers receive a 20% pension tax relief, higher rate taxpayers can receive 40% pension tax relief, and additional-rate taxpayers can receive 45% pension tax relief. Those living in Wales and Northern Ireland will receive pension tax relief at the same rates as in England. Those living in Scotland will receive pension tax relief at different rates, which we will discuss further down in this article.
There are two methods by which pension tax relief works – relief at source or net pay. Both have the same end result but have slightly different implications on how much you contribute out of pocket. If you’re an employee and have a workplace pension, your employer will choose one of the methods for you. If you have a personal pension like a SIPP (Self-Invested Personal Pension), typically, the relief at source method will be used.
Relief at source
With this method, the government will ‘top-up’ your pension contributions. Say you are a basic rate taxpayer, your employer will deduct tax from your taxable income as usual. They will then contribute towards your pension using your post-tax income, meaning that you have already paid tax on the income that’s been put towards your pension. The pension provider will then claim the 20% tax back in the form of a tax relief directly from the government without you having to do anything, and this will be added to your pension pot.
To give an example, suppose you earn £2,000 per month, are a basic rate taxpayer at 20%, and are paying 5% of your wages as pension contributions. Instead of paying £100 into your pension pot, your employer will only pay £80. The additional £20 will come from the government as pension tax relief.
If you are a higher rate or additional rate taxpayer, you will only receive 20% tax relief from the government. You will have to make a tax relief claim in order to receive the extra relief you are due. This can be done via a Self Assessment tax return.
With net pay arrangements, pension contributions are made on your pre-tax income, as is the case with a salary sacrifice scheme. In this scenario, you will only pay Income Tax and National Insurance on income after the pension contribution. This means that your taxable income will be lower, and therefore, your Income Tax and National Insurance contributions will be lower. Since tax has not been paid on the income that’s used for your pension contributions, you do not have to claim tax relief – you have already received it.
To use the above example, suppose you earn £2,000 per month, are a basic rate taxpayer at 20%, and are paying 5% of your wages into your pension pot. You will pay £100 directly into your pension pot and will only be charged tax on the remaining £1,900. Since you’ve not paid tax on the £100, you do not need to claim additional tax relief as it has already been given.
As such, you do not need to notify HMRC of your pension contributions by way of a Self Assessment tax return or through your Personal Tax Account.
Not everyone can claim pension tax relief, it is only given to those who satisfy all of the following criteria:
- Under the age of 75
- UK resident
- You make a gross contribution of up to 100% of your earnings, or up to £3,600 (£2,880 of your own money, the rest made up by government contributions)
The last point can be a little confusing, so here’s an example to explain what it means.
On the one hand, suppose you earn £30,000 in the 2022/23 tax year, and your pension scheme uses the relief at source method for pension tax relief. You will be able to make a total pension contribution of £30,000 (£24,000 through your payments, £6,000 with the basic rate tax relief) for that year.
On the other hand, suppose you are currently unemployed but have savings that you would like to contribute to your pension. You do not have any earnings for the 2022/23 tax year and are therefore only able to make a total pension contribution of £3,600 (£2,880 through your payments and £720 with the basic rate tax relief).
Whilst you can make a gross contribution of up to 100% of your earnings, there is a limit on how much you can claim tax relief, known as the Pension Annual Allowance. For the current 2022/23 tax year, this allowance is set at £40,000.
It should be noted that your unused Pension Annual Allowance can be carried forward for up to three years. In theory, you can have an annual allowance of up to £120,000 in a given year, but you would have had to be part of a pension scheme for all of those years.
As mentioned previously, there are two methods to receive pension tax relief – relief at source and net pay.
Relief at source
For basic rate taxpayers who are under a pension scheme that uses this method, they won’t have to do anything. The pension provider will claim the pension tax relief on your behalf and add it to your pension pot.
For additional or higher-rate taxpayers, they will have to complete a Self Assessment tax return in order to claim the extra tax relief.
You won’t have to do anything to claim pension tax relief for net pay pension schemes. Your pension contributions will be made with your pre-tax income, meaning you’ve already received the tax relief.
If you earn less than the £12,570 Personal Allowance and therefore do not pay any tax, you may get tax relief if you’re in a workplace pension. Whether you receive tax relief or not will depend on what tax relief method your pension scheme uses – relief at source or net pay.
If your employer uses the net pay method, you won’t receive tax relief on your pension contribution. Since your pension contributions are made using the pre-tax income, you will receive tax relief by having a lower tax bill instead. In this case, you’re not paying any tax since your income does not exceed the Personal Allowance. As such, you don’t benefit from pension tax relief.
Relief at source
Your pension provider will claim basic rate tax relief from the government automatically. Therefore, as long as your pension contributions don’t exceed your UK earnings, you will benefit from a 20% pension tax relief.
To visualise the difference between both methods, let’s take the below example:
|Tax relief method||Income||Pension contribution||Taken from pay||Tax relief|
|Net pay||£150 per week(£7,800 per year)||3%, £4.50 per week||£4.50||£0|
|Relief at source||£150 per week(£7,800 a year)||3%, £4.50 per week||£3.60||£0.90|
This example shows that whilst both methods contribute £4.50 towards your pension, with net pay, your contributions are all taken directly from your pre-tax income, and you can’t claim tax relief on it.
Relevant UK earnings are a source of income that you can claim tax relief on. It includes, but is not limited to, the following income streams:
- From employment e.g. salary, wages, bonus, commission, etc
- Rental income from the UK or EEA holiday lettings businesses
- Redundancy payments above the tax-free threshold of £30,000
- Patent income
- Taxable benefits in kind
- Profit-related pay
- Income from a trade or profession that’s conducted individually or as a partnership
Whether this is possible or not, and whether you will be eligible for tax relief on these contributions depends entirely on your employer and/or the pension provider. For instance, if you’re in a net pay arrangement with your employer, then additional pension contributions from someone else may not be possible.
If you have a workplace pension, it’s best to check with your employer first to see if this is possible. Then, you can contact your pension provider to see if they will allow external payments into your pension pot. If you are self-employed or have a private pension like a SIPP, then you can contact your pension provider to see if contributions from someone else are permitted.
Keep in mind that you won’t be able to claim tax relief on your pension contributions that exceed your relevant UK earnings or £3,600, whichever is higher.
There’s no upper limit to how much you can contribute to your pension over your lifetime. But, there is a limit on how much you can contribute if you want to enjoy the tax-relief benefits, and you don’t want to pay a tax charge when you access the funds or transfer them abroad. This is known as your Pension Lifetime Allowance.
For the current 2022/23 tax year, the Pension Lifetime Allowance is set at £1,073,100, and the government has announced that this allowance will remain the same for at least the next four years up to April 2026. If your pension value is above the Pension Lifetime Allowance, you will be charged a 25% tax if your funds are paid to you as income or 55% if paid as a lump sum withdrawal.
Scotland has different tax bands compared to England, but they too have relief at source and net pay pension schemes.
Relief at source
Scottish taxpayers who are under a relief at source pension scheme will receive tax relief at the tax rate. This means that basic rate taxpayers and non-taxpayers get tax relief at the basic rate of 20%. However, Scottish taxpayers who pay Income Tax at the starter tax rate of 19% will receive tax relief at 20%. Those who pay tax at a rate of 21%, 41% and 46% can claim the additional tax relief they are owed using the Self Assessment tax return, the same as the rest of the UK.
Net pay arrangements in Scotland work exactly the same as they do in England, meaning no action will need to be taken. It should be noted that Scottish taxpayers who pay tax at the 19% tax rate will only receive tax relief at 19%. This means that, unlike taxpayers who are under a relief at source pension scheme, they will not be paid tax relief at 20%.