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Pension tax relief explained

What is pension tax relief, how it works, how to claim pension tax relief, tax-free pension allowances and claiming higher rate tax relief.

Pensions are one of the most tax-efficient ways to save for your future. In this article, we'll explain everything you need to know about tax relief on pensions in simple, everyday terms.

What is pension tax relief?

You've probably heard that the main benefit of saving into a pension is tax relief. But what does that mean in real money terms?

The UK government wants to encourage you to save for life after work. They do this by offering a 'bonus' on contributions into your pension pot. This bonus comes from tax relief.

How does pension tax relief work?

Every time you pay into your pension, that money is exempt from tax. So if you're a basic rate taxpayer, adding £100 into your pot means you no longer owe the 20% basic rate income tax on that £100. This is true, even if you're self employed.

The government then 'refunds' this tax into your pension pot as a 'tax bonus'. So using the £100 example, you'll get £25 extra in your pot. Here's why.

You've already paid tax on the £100 you added to your pension. If you hadn't, your £100 would have been £125 - that's because £125 taxed at 20% is £100.

So, to make up the difference, the government refunds you £25 back into your pension. This is why you may see the pension tax bonus described as 25%. A 25% bonus on £100 is £25. £100 + £25 = £125.

Higher and additional rate taxpayers get to benefit from even more tax relief. Scroll down to check out how UK pension tax relief works for higher earners.

Tax relief on pension contributions is one of the main advantages of pensions when it comes to saving for the future.

How do I claim pension tax relief?

Thankfully for most of us, claiming pension tax relief is easy.

When you pay into a private or personal pension, your provider will claim pension tax relief back on your behalf. As soon as your contribution has been processed and approved by the government, your tax bonus will be added to your pot automatically. This normally takes 2-3 months.

If you're contributing to a workplace pension scheme, pension payments are made before tax deductions so again, there's nothing for you to do.

If you're a higher or additional rate taxpayer, you'll need to claim your extra relief via a self-assessment tax return, or by calling or writing to HMRC. Read on for more information on how that works.

How far back can I claim pension tax relief?

If you're thinking about claiming tax relief on pension contributions for previous years, you only have a limited time to do so.

You have four years from the tax year of the relevant pension contribution to let the government know you're owed tax relief on your payment.

Tax-free pension allowance

An important thing to bear in mind with pension tax relief is your pension tax limits. Everyone is entitled to tax relief on pension contributions up to 2 key thresholds: the annual allowance and the lifetime allowance.

The pension tax allowance limits mean that you will only benefit from tax relief on a certain amount each tax year. The annual limit is:

  • £60,000, or
  • 100% of your earnings

You can still contribute to your pension above this amount - you just won't benefit from tax relief on any payments above this threshold. It's also worth knowing that you can carry over any unused allowance for up to three tax years.

The next limit to be aware of is the lifetime allowance. This is the total amount you can hold in your pension pot while still getting tax relief on contributions.

Currently, this limit is £1,073,100. If you go above this limit, you may have to pay tax on your pension.

The government announced that from 6 April 2023 the lifetime allowance charge would be removed. The lifetime allowance will be fully abolished from the 2024 to 2025 tax year, through a future Finance Bill.

pension tax relief

Claiming higher rate tax relief on pension contributions

As we discussed, everyone is able to benefit from 25% tax relief on their pension contributions.

Tax relief on pension contributions for high earners works a little differently, however. Higher and additional rate taxpayers get to enjoy even more tax relief when they contribute. Here's how it works.

Currently, in the UK, higher rate pension tax relief is 40% on earnings above £50,270. That means your pension contributions are able to get 40% back as tax relief. You'll get the first 20% added to your pot automatically. The remaining 20% you'll need to actively claim back from HMRC via a self-assessment tax return, or by calling or writing in.

Let's look at some examples. If you're a basic rate taxpayer, you'll need to add £80 if your own money to get £100 into your pension. That's £20 back from the government, a 25% bonus.

With the higher rate tax relief on pension contributions, you'll only need to add £60 of your own money to get the same £100 in your pot. That works out as a 66% tax bonus.

For additional rate taxpayers, you'll enjoy 45% tax relief on each contribution. £55 of your money means £100 in your pension - a tax bonus of over 80%. Not bad.

For more on this, check out our guide to claiming higher rate tax relief via your tax return.

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1. Get a Penfold account by registering your details online or with our app.

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