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There are many reasons why you might consider paying into a pension. One clear benefit of pension contributions is tax relief. To encourage the nation to save for retirement, the Government implemented the tax relief scheme which gives an instant top up to savings intended for later life.

Understanding how tax relief works for you is crucial to help you financially plan smarter, more effective ways to reach your retirement goals. In this article, we’ll explain the basics of pension tax relief and how it can help you build up your retirement fund.

Understanding tax relief on pensions

How much relief you receive depends on how much tax you pay. If you are a basic-rate taxpayer or don’t currently pay tax, you’ll be entitled to 20% relief. Higher-rate taxpayers can receive 40%, and additional-rate taxpayers get 45%.

However, be aware, if you’re a higher-rate or additional-rate taxpayer, pension tax relief rules stipulate that any relief above 20% needs to be claimed via a self-assessment tax return.

Remember though, you only receive relief on 100% of your earned income. So, if your annual income is £40,000, but your contributions are higher than that, you’ll only receive tax relief on the £40,000.

If you’re employed and paying into a workplace pension, you can receive tax relief in two ways: relief at source or net pay. It’s usually your employer that decides which option you’ll move forward with.

Relief at source

When using the relief at source scheme, your pension contribution will be removed from your ‘take home’ pay. This is the income you receive after paying tax and National Insurance. Your employer will only deduct 80% of your pension contribution from your salary. Your pension provider automatically adds the other 20% to your pension pot which it claims back from HMRC.

Net pay

When using the net pay option, pension contributions are taken out of your monthly pay before tax. Then, you’ll only pay tax on the remaining amount of salary which is considered tax relief. For anyone who doesn’t pay tax but does pay into a pension, using the net pay scheme means you do not receive tax relief.

Workplace pension contributions don’t just benefit you. Your employer is allowed to claim employer pension contributions as business expenses, reducing their overall corporation tax bill.

Pension tax relief for the self-employed

If you’re paying into a private pension, you’ll always receive relief at source. If you are self-employed, you can set up a personal pension. Through this, you can make regular or ad-hoc payments at times that suit you.

Similarly to a workplace pension, the money you pay in in will be eligible for a Government top up. For people who are self-employed, this equates to an additional 25%. So, for every £100 you invest, you get £25 back.

Also, any money you add to your pension is counted as a tax-deductible expense. When finalising your self-assessment tax returns, make sure to add any pension contributions to benefit from a lower tax bill.

Maximising tax relief through pension contributions

Pension contributions reduce your taxable income, ensuring that your hard-earned money is invested in your future. If you’re auto-enrolled into a workplace pension scheme or paying into a private pension, there are ways to ensure you’re maximising the pension tax relief available to you.

  1. Contribute up to your annual allowance of £60,000 where possible. This is the most you can save into your pension without incurring additional tax charges. Be aware however that this £60,000 includes any money you and your employer contribute.
  2. Carry forward any unused pension tax relief allowance. If you were only able to save £40,000 in 2023, you’re allowed to carry forward the remaining £20,000 for the next three years without needing to pay additional tax charges and maximise tax relief.
  3. Ask your employer to contribute more. While an employer doesn’t have to match your pension contributions, it doesn’t mean they won’t. Employees currently contribute a minimum of 8% into their pensions, 3% of which is paid by the employer. Sometimes, if you choose to pay more into your pot, employers will match this.

Tax relief limits and restrictions

It’s important to understand your pension contribution limits to ensure you don’t get caught out by additional taxes.

Annually, you can save a maximum of £60,000 into your pension pot without needing to pay tax. This is for all pension pots combined and includes any money your employer contributes as well. This year (2023/2024), you’ll need to pay either 20%, 40%, or 45% on any excess contributions. This depends on which tax bracket you’re in.

Your annual allowance for pension tax relief limits may be lower than £60,000 if you have either flexibly accessed your pension pot or have a high income.

There’s also a lifetime restriction on how much money you can save into your pension:  £1,073,100. Nevertheless, as of April 2023, unlike the annual allowance, there is no longer a charge for going over this amount. In April 2024, the Lifetime Allowance is due to be scrapped altogether. This surprise move in the 2023 Spring Budget was implemented to encourage people to work for longer.

In conclusion

Effective pension tax planning can ensure you’re making your money work as hard as it can for you. You can do this by using your allowances and making the most of the Government’s tax relief scheme. While there are certain limits that need to be considered, paying into a pension has numerous benefits that will support you later in life and help you to reach your goals in retirement.

We excel in guiding you through the complexities of pension tax relief in the UK. Our dedicated team offers expert advice to ensure your pension contributions are aligned with your long-term financial goals, maximising tax efficiency. Discover how our comprehensive pension services can demystify tax relief processes, providing you with both clarity and confidence. Visit our Pension Tax Relief page today to gain valuable insights and embark on a journey towards a tax-efficient retirement strategy.