How does pension tax relief work?
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
Pension tax relief is a system designed to encourage people to save towards their retirement. Yet how does it work, exactly? How can you best use it to boost your savings and achieve your long-term financial goals? In this guide, our Grantham-based financial planners at Castlegate explain what you need to know about pension tax relief and how it can be integrated into an effective retirement plan. We hope this is helpful. If you want to discuss your financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
How do pension contributions work?
When an employed person receives a monthly wage, a portion of that wage is taken away as income tax (via PAYE) – together with National Insurance (NI) contributions and perhaps also student loan repayment. You will normally see these indicated on your payslip. You may also see the phrase “Er pension” on there, which refers to how much your employer contributed to your pension that month.
In the background, you will likely be contributing to your workplace pension via “auto enrolment” (unless you opted out). In 2022-23, you are required to contribute at least 5% of your salary to your pension. Your employer is also obliged to put in 3% (totalling 8%). You can choose to put in more, however, if desired. Employers sometimes also offer “contribution matching” – i.e. they will contribute at the same rate as you (normally up to a limit).
For instance, if you commit to putting 10% into your pension, your employer may do the same – effectively doubling your contribution.
What is pension tax relief?
Imagine you got paid £100 and you are a basic rate taxpayer. Assuming your £12,570 Personal Allowance is used up for the year, this would leave you with £80 due to the 20% tax rate. What if you want to put this money straight into your pension? Here, tax relief applies and “boosts” the value – in line with your highest marginal rate of income tax. In this case, the 20% Basic Rate is relevant and so the £80 contribution is boosted to £100. In effect, the money that should have gone to the UK government in tax (£20) has, instead, gone straight into your pension.
There are two ways that pension tax relief can work in the UK. The first is pension tax “relief at source”. Here, your pension provider claims tax relief from the government on your behalf. This means that the contribution is deducted from your pay before tax is calculated. Then, the pension provider claims the tax relief back from the UK government (e.g. 20%). The second approach is called “net pay”. With this method, your pension contributions are made before you are taxed. This can lead to paying a lower rate of tax and you do not need to claim full tax relief to get it.
How to get the most from pension tax relief
For those paying the Higher Rate or Additional Rate of income tax, it is crucial to remember that you get 20% pension tax relief automatically through your employer. However, extra tax relief needs to be claimed via your Self Assessment Tax Return (i.e. 20% or 25%, respectively). If you find yourself unemployed at the moment, or you earn under £3,600, then you can still contribute to a pension. For instance, perhaps you do this from cash savings or by getting your partner to contribute on your behalf. However, tax relief is only available on contributions under £3,600.
It also helps to know other limits on pension contributions and tax relief. In 2022-23, you can put up to £40,000 into your pension(s) each tax year under your “annual allowance” (or, up to 100% of your earnings – whichever is lower). If you have triggered the MPAA (Money Purchase Annual Allowance) rules, however, then you will be limited to a maximum annual allowance of £4,000. Some taxpayers may be able to use “carry forward” to utilise unused annual allowance from the past three tax years. In theory, this could allow someone to put £160,000 into a pension in one tax year. However, speak with a financial adviser before making a large contribution like this.
Please be aware that the UK Chancellor recently abolished the lifetime allowance (the tax-free “cap” on an individual’s pension savings) in his 2023 Spring Budget. Previously, the lifetime allowance was set at £1,073,100 and was expected to remain frozen at this level until 2026. This change will take a lot of pressure away from many pension savers who were worried about inadvertently breaching their tax-free allowance. However, bear in mind that this change could be a political target in the next UK general election. Speak with a financial planner to explore your options for building a retirement fund.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
