Tax relief on pension contributions: how does it work?

If you pay money into a pension, you may be able to get tax relief on your contributions. We reveal everything you need to know.

The UK Government encourages people to save for their retirement by offering tax relief on private pension contributions.

This tax relief reduces your tax bill and boosts your pension pot as the money that would have gone to the Government in tax is added to your pension.

Tax relief on pension contributions applies to most private pensions including workplace pensions, personal and stakeholder pensions, and recognised overseas pension schemes.

You receive tax relief on your pension contributions at the highest rate of Income Tax that you pay.

For Basic Rate taxpayers, this is 20% although the tax rate rises to 40% and 45% for Higher and Additional Rate taxpayers, respectively.

While you can put as much money as you like into your pension fund, unfortunately you can’t claim tax relief on all of your contributions.

There are annual and lifetime limits on how much you can save tax-free for your retirement.

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Claiming tax relief

You won’t need to claim tax relief if your employer takes your workplace pension contributions out of your pay before deducting Income Tax, or if your pension provider claims it at a rate of 20% on your behalf.

But you can claim tax relief as part of your Self Assessment tax return if your pension fund isn’t set up for automatic tax relief or you pay Income Tax at a rate of over 20%.

As tax relief is automatically paid at 20%, if you are a higher or additional rate taxpayer, you should be able to claim the additional 20% or 25% in your Self Assessment tax return.

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HMRC form. (Image: Shutterstock)

How the Annual Allowance works

For the tax year 2019/20, the Annual Allowance for tax relief on pension contributions is currently capped at £40,000.

But if you earn less than the £40,000 allowance, you’ll receive tax relief on pension contributions on up to 100% of your annual earnings.

For example, if you earn £15,000 a year but topped up your pension pot by £20,000 using your salary and savings, you only receive tax relief on £15,000 – as that is 100% of your annual salary.

The remaining £5,000 may be subject to tax.

Alternatively, if you earn £50,000 a year and put the total amount into your pension pot, you will only receive tax relief on the first £40,000. The remainder may be subject to Income Tax at the highest rate you pay.

The Annual Allowance applies to all the pension schemes you belong to.

So, if you’re paying into a work pension and another private pension, your allowance across both schemes combined is £40,000, not £40,000 per fund.

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Carrying over your Annual Allowance

Depending on your circumstances, it may be possible to carry forward unused Annual Allowances from the previous three years to top up your allowance in the current tax year.

Use the GOV.UK calculator to find out if you can carry any previous Annual Allowances over to this tax year.  

A man putting money into a piggy bank. (Image: Shutterstock)Money Purchase Annual Allowance

If, for any reason, you decide to withdraw money from your pension pot but continue to pay into it at a later date, you may be subject to a lower allowance of just £4,000, which is the Money Purchase Annual Allowance (MPAA).

If this happens, you’ll no longer be able to carry over Annual Allowances from previous years.

For anyone with more than one pension pot, if your allowance drops to £4,000 for one of your funds, you will need to tell any other pension schemes you are a member of within 13 weeks.

There is also a reduced allowance for people with low or no income.

If you earn less than £3,600 a year, you can make gross contributions of up to £3,600 per tax year and receive basic rate tax relief on your contributions.

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Tapered Annual Allowance

In April 2016, a Tapered Annual Allowance was introduced to restrict pension contribution tax relief for high earners, predominantly those earning over £150,000.

If your adjusted income is in excess of £150,000, your Annual Allowance in the same tax year will be cut.

So, for every £2 you earn over £150,000, you’ll lose £1 of your Annual Allowance. The minimum reduced annual allowance is £10,000.

What is the lifetime allowance?

The lifetime allowance outlines the maximum amount you can accumulate in your pension before you pay tax on it, which is currently £1.055 million. This is set to rise to £1.073 million in April.

If you’re unsure about how much of your Annual Allowance you have used, you should consult your pension provider.

You may need to contact more pension providers, depending on how many schemes you have signed up to.

If you exceed your lifetime allowance, your pension provider will tell you how much tax you need to pay. This amount will be deducted before you get your pension.

The current rate of tax for payments in excess of the lifetime allowance is either 55% or 25%, depending on whether you receive your fund as a lump sum or as pension payments. 

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