How does tax relief on pensions contributions work for the self-employed?

  •  By
  •  Murray Humphrey

When you’re self-employed and wearing a different hat each day of the week, setting up and contributing to your pension can easily slip to the bottom of your priority list. Whereas employees are automatically enrolled in a pension scheme and their contributions are taken care of. Yet when you work for yourself, setting up a pension is one of many tasks that you are responsible for.

The good news for the self-employed is that there is still a huge tax incentive to boost your pension up the priority list and get started. The government tops up your self-employed pension pot with tax relief when you contribute. The concept of tax relief isn’t always clear, so let’s break it down.

What is tax relief? How much can I get?

The government incentivises people paying into their private pension by paying back a portion of the tax you’ve already paid. This is known as tax relief.

Take a basic rate taxpayer in England, you’ll pay 20% tax on anything that you earn over the personal allowance of £12,500. For example, if you earn £2000 in one month, you will pay £400 in tax on that income, leaving you with £1600.

However, if you put that £1600 into a pension plan, the government will give you the £400 tax back into your pension pot in the form of tax relief. This is equivalent to the government topping up the contributions you make into your pension by 25%!

If you are a higher rate taxpayer, you can enjoy even more tax relief of up to an extra 25%! Your contributions into your Penfold pension will automatically receive the 25% tax relief, but because you’re paying the higher rate tax, the government will pay back the tax you’ve already paid by offsetting it against your self-assessment tax return. This means that a contribution of £1600 into your pension will have £400 added on top by HMRC, and you’ll also be able to claim up to an extra £400 in your self-assessment tax return.

Remember, pension & tax rules apply and are subject to change, and the amount that you are due to receive in tax relief can vary due to individual circumstances.

Are pension contributions tax deductible for sole traders?

As you’ve received tax relief already on your pension contributions, as explained above, they won’t reduce your tax bill (unless you’re a higher rate tax payer). However, you don’t pay any tax on these contributions, so make sure to enter the information in your tax return! If you’re a Penfold customer, please get in touch on our online chat box or through email here and we’ll send you a PDF of all your pension contributions this tax year.

If you're a limited company director, your pension contributions from your company are deductible from your corporation tax bill. There's a tonne of other benefits of contributing into a pension as a director, head here to read more.

How much tax will I pay on my pension?

The maximum amount you’re allowed to contribute into your pension each year and receive the relevant tax relief on those contributions is your net yearly earnings. For non limited company directors, your yearly earnings count as your company’s total profit, before tax.

The maximum you’re allowed to contribute into your pension each year and not pay a tax charge is £60,000 or your annual salary, whichever is lower. This is called the Annual Allowance and it applies to everyone, regardless of income or employment. Any contributions over this limit is subject to a tax charge.

This £60,000 amount includes all of your personal and employer contributions and any tax relief that’s added by the government on top of this. So make sure you’re not contributing anything over this amount, even if your company has earned more within that financial year!

Do you pay tax on a pension?

When you withdraw money from your pension in the future, you are able to withdraw 25% of your pension pot tax-free and the remaining 75% is taxed as income (at your marginal rate). So, how much tax you pay will depend on how much of your pension you withdraw within the year and your individual circumstances.

Join thousands already using Penfold’s pension for the self-employed with flexible contributions, automatic tax relief, a transfer service that does the paperwork for you and much more.

A photo of Murray Humphrey

Murray Humphrey