8th March 2023 - Tim Foster

Explained: How pension tax relief works and boosts your retirement savings

Tax relief could boost your pension and mean you have more financial freedom in retirement. Yet it’s something that you may overlook when reviewing your pension, as analysis suggests that some workers aren’t claiming their full entitlement.

In fact, according to a report in the Telegraph, higher- and additional-rate taxpayers could have missed out on as much as £811 million of tax relief in the 2021/22 tax year.

So, how does pension tax relief work? Read on to find out.

Tax relief is like a bonus the government gives when you save for retirement.

A pension provides a tax-efficient way to save for your future because of the tax relief you receive. Essentially, when you add money to your pension some of the money that would have gone to the government is added to your savings instead.

When you consider how this could add up over the long term, it means saving for retirement through a pension makes sense for two key reasons.

  1. More money is going into your pension when you contribute so you could have a larger pot when you retire. As the money held in your pension is often invested, tax relief, along with other pension contributions, could grow further during your working life.
  2. As saving into a pension is tax-efficient, contributing could reduce your overall tax liability. However, you should keep in mind that pension savings usually are not accessible until the age of 55, rising to 57 in 2028.

The way tax relief is given on contributions depends on the type of workplace pension that your employer is using. The two main methods are as follows:

1. Net pay arrangement

Your employer deducts your contributions from your pay before it is taxed and paid out to you – so you only pay tax on what you earn after your pension contribution has been deducted. This means you get full tax relief at your highest ‘marginal’ rate of income tax.

If you don’t pay UK income tax – for example if your earnings are below the current personal allowance of £12,570 – your contributions will be deducted before salary is paid out to you. However, you won’t benefit from tax relief using this method. 

This method of tax relief applies to occupational pension schemes.

2. Relief at source

Here, your employer deducts your contributions from your pay after it’s taxed. Your pension scheme will then automatically add basic-rate tax relief (regardless of your tax status) to your pension fund when they receive your contribution. So, if you contribute £80 from your pay to your pension, you’ll receive £20 in tax relief, meaning a total contribution to your pension of £100.

If you’re a non-taxpayer, you will still get basic-rate tax relief on your contributions up to a certain level.

Tax relief for personal pension schemes is given using the relief at source method.

You may need to fill in a self-assessment tax return to claim your full entitlement.

If you are contributing to a workplace pension/personal pension with the relief at source method, tax relief of 20% will usually be automatically added to your pension.

If you are a higher or additional-rate taxpayer, you will usually need to complete a self-assessment tax return to receive your full entitlement. You’d normally receive this additional tax relief through a tax rebate.

It’s worth checking you’re receiving all the tax relief you’re entitled to, even if you believe it’s automatically added to ensure you’re not missing out. The Telegraph report indicates this is something many workers are overlooking.

How much tax relief can you claim?

If you can, contributing more to your pension could mean you receive more in tax relief so your money goes further.

There are limits to how much you can add to your pension before you could face an additional tax charge when you access your savings. These thresholds include the:

Contact us to talk about your pension.

Pensions can be confusing and you may not be sure if you’re saving enough for the retirement you want. Contact us to talk about your long-term goals and the steps you could take now to help you reach them.

Risk Warnings

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

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