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Pension Tax Relief Explained

Contributions & Tax 6 min readGuide 5
Pension Tax Relief Explained

Pension tax relief is the government's top-up on your pension contributions. This guide explains how relief at source and net pay work, how much you can claim and how higher-rate taxpayers can claim additional relief.

Quick answer

Pension tax relief is the government's top-up on your pension contributions. Basic-rate taxpayers receive 20% relief, meaning £80 of your money becomes £100 in your pension. Higher-rate taxpayers can claim 40% relief, and additional-rate taxpayers 45%. How the relief is applied depends on whether your scheme uses relief at source or a net pay arrangement.

What is tax relief?

When you earn money, you pay income tax on it. When you put money into a pension, the government gives back the tax you would have paid, effectively allowing you to save from your pre-tax income. This is pension tax relief.

The amount of relief you receive depends on your marginal rate of income tax. Basic-rate taxpayers (20%) receive 20% relief. Higher-rate taxpayers (40%) can receive 40% relief in total. Additional-rate taxpayers (45%) can receive 45% relief.

In practical terms, for a basic-rate taxpayer, every £80 you contribute results in £100 going into your pension. For a higher-rate taxpayer, every £60 you contribute can result in £100 going into your pension, making pensions one of the most tax-efficient savings vehicles available.

Relief at source

Most workplace pensions use a method called relief at source. Under this arrangement, your contributions are deducted from your net (after-tax) pay. Your pension provider then claims basic-rate tax relief (20%) directly from HMRC and adds it to your pension pot.

This happens automatically, you don't need to do anything to receive the basic-rate relief. However, if you are a higher-rate or additional-rate taxpayer, you only receive the basic 20% automatically. You need to claim the additional relief separately through your self-assessment tax return.

Net pay arrangements

Some workplace pensions, particularly those in the public sector and some larger employers, use a net pay arrangement. Under this method, contributions are deducted from your gross (before-tax) pay. This means you automatically receive full tax relief at your marginal rate without needing to claim anything separately.

Net pay arrangements are generally simpler for higher-rate taxpayers because the full relief is applied automatically. However, they have a disadvantage for non-taxpayers, workers who earn below the personal allowance do not benefit from tax relief under a net pay arrangement, whereas they would under relief at source.

Steve

Steve's observation

One of the most common pieces of unclaimed money I come across is higher-rate tax relief on pension contributions. Many higher-rate taxpayers don't realise they need to claim the additional 20% through their self-assessment return, and some have been missing out for years.

If you are a higher-rate taxpayer and your scheme uses relief at source, you should be claiming the additional relief every year. The amounts can be significant, if you contribute £10,000 per year to your pension, you could be entitled to an additional £2,000 refund from HMRC.

If you don't complete a self-assessment return, you can write to HMRC directly to claim the relief. You can usually claim for up to four previous tax years, so it is worth checking whether you have missed any claims.

Claiming higher-rate relief

If your scheme uses relief at source and you are a higher-rate taxpayer, you need to claim the additional relief through your self-assessment tax return. You declare the total amount of pension contributions you have made in the tax year, and HMRC will either adjust your tax code or issue a refund.

If you do not complete a self-assessment return, you can contact HMRC directly to claim the relief. You can usually claim for up to four previous tax years, so if you have been missing this relief, it is worth making a backdated claim.

Non-taxpayers and tax relief

Non-taxpayers, those who earn below the personal allowance, can still benefit from pension tax relief under a relief at source arrangement. They can contribute up to £2,880 per year and receive basic-rate relief, meaning £3,600 goes into their pension. This is a valuable benefit for non-working spouses or partners, for example.

Under a net pay arrangement, non-taxpayers do not benefit from tax relief, as contributions are deducted from gross pay and there is no tax to reclaim.

The annual allowance limit

You can receive tax relief on pension contributions up to 100% of your UK earnings in a tax year, subject to the annual allowance, currently £60,000. All contributions count towards this limit, including your own contributions, your employer's contributions and tax relief.

If your total contributions exceed the annual allowance, you will face an annual allowance charge, effectively a tax charge that claws back the excess relief. Guide 7 covers the annual allowance in detail.

Pause for thought

  • Do you know whether your workplace pension uses relief at source or a net pay arrangement?
  • If you are a higher-rate taxpayer, are you claiming the additional tax relief through self-assessment?
  • Have you checked whether you have any unclaimed higher-rate relief from previous tax years?
  • If you have a non-working partner, have you considered making pension contributions on their behalf to benefit from tax relief?

Coaching point

If you are unsure whether your scheme uses relief at source or net pay, check your payslip. If contributions are shown as a deduction from your net pay, it is likely relief at source. If your gross pay is reduced before tax is calculated, it is likely net pay or salary sacrifice.

Key terms

Tax reliefThe government's top-up on pension contributions, equivalent to the income tax that would have been paid on the contributed amount.
Relief at sourceA method where contributions are deducted from net pay and the pension provider claims basic-rate relief from HMRC. Higher-rate relief must be claimed separately.
Net pay arrangementA method where contributions are deducted from gross pay, so full tax relief is applied automatically at the employee's marginal rate.
Marginal rateThe rate of income tax you pay on your highest band of earnings, 20% (basic), 40% (higher) or 45% (additional).
Annual allowanceThe maximum amount that can be contributed to your pension in a tax year while still receiving tax relief, currently £60,000.
Self-assessmentThe HMRC system for reporting income and claiming tax reliefs not automatically applied through PAYE.

Frequently asked questions

What to do next

Find out which method your scheme uses, relief at source or net pay. If you are a higher-rate taxpayer and your scheme uses relief at source, check whether you are claiming the additional relief through self-assessment.

Guide 6 explains employer pension contributions in more detail, including how to find out what your employer contributes and how to take full advantage of employer matching.

This guide provides general information only and does not constitute personal financial, pension, investment or tax advice. Tax relief rates and annual allowance limits are set by the government and may change. Higher and additional-rate taxpayers should consider taking advice on claiming additional tax relief. Appropriate regulated financial advice should be considered before making significant pension decisions.
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