A pension is one of the most tax-efficient ways to save for your future. When you save into a pension, the government provides tax benefits as a way of encouraging and rewarding those who contribute. HMRC will provide a top-up on every personal contribution you make and although there are certain limits and rules that govern this tax relief, it’s not as complicated as it may seem.
How does tax relief on pension contributions work?
When you earn tax relief on your pension, some of the money that you would have paid in tax on your earnings goes into your pension pot rather than to the government. Tax relief is paid on your pension contributions at the highest rate of income tax you pay. So…
- Basic Rate taxpayers claim pension tax relief at 20%
- Higher Rate taxpayers claim pension tax relief at 40%
- Additional Rate taxpayers claim pension tax relief at 45%
On this basis, if you are a basic rate taxpayer and were to contribute £1,000 into your pension, the actual cost to you as the contributor is £800, as the government adds £200 on top – the tax you would have had taken on this amount. Higher rate (40%) and additional rate (45%) taxpayers need only contribute £600 and £550 respectively to achieve the same £1,000 in pension savings.
How do I claim pension tax relief?
The way by which you claim the tax relief on pension contributions is dependent upon the type of pension you are paying into, as some schemes require some extra work to acquire the full relief you are entitled to.
If you are claiming pension tax relief from a ‘net pay’ arrangement, you do not need to do anything to get your full tax relief. The contributions are deducted from your salary before income tax is paid on them, and the pension scheme provider automatically claims back the tax relief at your highest rate of income tax. This kind of arrangement is used for some workplace pensions.
The alternative is a ‘relief at source’ arrangement, which applies to all personal pensions, and some workplace pensions. If you are paying into a pension through your employer, when calculating your pay they will take 80% of your pension contribution from your salary, with your pension scheme provider claiming the additional 20% from HMRC on your behalf. The key under this system is that higher and additional rate taxpayers will need to claim the additional tax relief on their contributions via a Self-Assessment Return, as only the basic rate relief is claimed when the contribution is made.
How much pension tax relief can I receive in 2021/22?
There is a limit imposed by the Government on the amount of pension contributions that you can earn tax relief on, commonly referred to as the pension’s annual allowance. You can save 100% of your income, providing it does not exceed the limit of £40,000 for 2021/22 tax year. Basically, the total of your employer contributions, personal contributions and HMRC top ups cannot exceed this amount across a tax year.
Any pension payments made over the £40,000 limit will be subject to income tax at the highest rate your earnings require you to pay. However, you are able to carry forward unused allowances from the previous 3 tax years, provided that you were a member of a pension scheme at that time.
Claiming pension tax relief as a non-taxpayer or low earner?
Non-taxpayers, including spouses who aren’t in employment and children, are eligible for tax relief of 20%, even though they don’t pay tax.
Remember, you can save 100% of your income into a pension to earn tax relief, so long as it doesn’t exceed £40,000 in a year. So, if you earned £5,000 a year, you could save £5,000 into a pension.
However, if you earn £3,600 or less, including individuals that have no income, the maximum contributions allowed are £3,600. This includes the government top-up, so the actual personal contribution can be no higher than £2,880.
If you are concerned about your pension situation and are curious to understand if you are maximising your tax efficiency, and reclaiming the full amount of tax relief that you are entitled to, please do not hesitate to contact us and arrange a meeting to discuss your position.