Learn > Pensions > Tax Relief

What is it?

You might have heard people discussing the tax relief you can receive on pension contributions, but you aren’t actually sure what it means or how it works. Let’s have a look together.

The Government wants people to save money in pension pots for their retirement as it looks bad if the UK has a whole age demographic who can’t support themselves financially. To push people to save into pensions they offer something called “tax relief” for contributions into pension pots.

So normally, if you didn’t put money into a pension pot, you would pay tax on your income. This could be at 20%, 40% or 45% (for more on this see Income Tax here.) However, if you decide you want to put some money aside for retirement the Government basically don’t charge you the tax on this amount.

Let’s look at an example:

David is a basic rate taxpayer (20%) and wants to contribute 3% of his earnings into his workplace pension.

Assuming that David earns £20,000, 3% of this is £600 for the year.

Yet, what happens is because he can gain tax relief on this, instead of £600 being taken from his wages we figure out what 20% of this is.

Therefore, £120 of this amount doesn’t actually get paid by David.

Instead he pays £480 through his payslips and this goes into his pension pot.

Then the Government top this up by paying in £120 as a reward for saving.

Higher or Additional Rate?

Of course, this is even better for those who earn more. If you are paying 45% tax at the higher rate it is almost a no brainer whether to contribute only 55% of your own money into a pension pot. The tax relief works the same at every tax level, just with higher rewards the more you are earning.

If you are a non-tax payer for any reason, you can also gain tax relief at 20% so not to punish those on low earnings.

What’s the catch?

Unless you are on colossal money, there really isn’t one. You can contribute 100% of your annual income into a pension to gain tax relief, so long as this is below £40,000. Meaning if you were earning £200,000 and you contributed £40,000 a year to your pension you would only need to pay in £22k and the Government would cover the other £18k.

You can carry forward any unused pension allowances for 3 years, this means if you were in a pension scheme from 18 years old and contributed £500 a year (including tax relief) for the first two years, you would have an allowance of £119,000 for the 3rd tax year.

However, this is where you need to be wary. If you go over your pension allowance for the year, anything in excess of the allowance (normally £40k) will be taxed at the highest rate of tax you pay.

Example:

If you paid in £41,000 and you were a higher rate tax payer you would pay 45% tax on the £1,000 excess contribution.

How do I get relief?

For both personal pensions and workplace pensions, relief is given at source so you needn’t worry about this as it will be dealt with for you.

If, however, you are interested in maximising your pension contributions it is worth speaking to a financial adviser.

Do you need a financial adviser? We can put you in touch.

Should you have any further questions about tax relief and how it works, send us an email

hello@thebankengine.com