Tax Relief and Pensions: A Short Guide

In this guide, we’ll examine the tax efficiencies involved, examine different pension schemes and explore strategies to maximise the benefits.

Types of pension scheme

You may have been paying into a workplace pension such as a Defined Contribution (DC) or Defined Benefit (DB) scheme:  

• With a DC scheme, your pension pot will be based on how much has been paid in and invested, so your income will depend on the fund’s performance.    
• With a DB scheme, your benefit will be based on the level of your salary when you retire and how long you've worked for your employer.

You may also have a personal or private pension, such as a Self-Invested Personal Pension (SIPP) or a stakeholder pension.

Tax-free pension allowance

The government offers tax relief on pensions to encourage people to save for the future. So, you’ll get tax relief on your private pension contributions up to 100% of your annual earnings (or up to the £60,000 annual allowance in 2024-25; whichever is lower). This is the maximum amount you can contribute to your pension each year with the benefit of tax relief.

How pension tax relief works

Every time you contribute to your pension fund, you won’t be paying any income tax on that amount.

For example, if you’re a basic rate taxpayer and add £100 to your pot, you’ll no longer have to pay the 20% rate income tax on that £100. Because the government is 'refunding’ this tax as a bonus, you'll get an extra £25 in your pension pot.

Look at it this way. You've already paid tax on the £100 you added to your pension. If you hadn't, your £100 would have been £125, because £125 taxed at 20% is £100. So, to make up the difference, the government refunds you £25 back into your pension.

How do you claim?

In most cases, claiming pension tax relief is easy and happens automatically. You’ll get tax relief in this way if your employer takes workplace contributions out of your pay before deducting Income Tax. Or if your pension provider claims tax relief from the government at the basic 20% rate, known as ‘relief at source’, and adds it to your pension pot.

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.

You’ll also have to manually claim the relief if your pension scheme is not set up for automatic tax relief or someone else pays into your pension.

Carrying forward your allowance

If you haven’t used all your annual allowance in the previous three years, you’re entitled to carry forward the unused amount to the current year, as long as you were a pension scheme member during that time.

This is an effective way of increasing your contributions and tax relief benefits.

Tax relief for higher and additional rate payers

Higher and additional rate taxpayers benefit from even greater tax relief when they make their pension contributions.

In the 2024/25 tax year, if you’re a higher-rate taxpayer, you’ll get pension tax relief at 40% on earnings above £50,270. This means you'll get the first 20% added to your pension fund automatically, and you can claim the remaining 20% via your self-assessment tax return or by calling or writing to HMRC.

Let’s consider how that works. A basic rate taxpayer needs to add £80 of their own money to get £100 into their pension, £20 back from the government, or a 25% bonus. But if you’re a higher-rate taxpayer, you'll only need to add £60 of your own money to get the same £100 in your pot - i.e. £40 back, or. a 66% tax bonus.

And if you’re an additional rate taxpayer, (earnings above £125,140), you'll get 45% tax relief on each contribution. So £55 of your own money, £45 back - and a tax bonus of over 80%.

What if you’re self-employed?

If you’re self-employed, putting money aside for later life is just as important. You may not be able to benefit from employer contributions. However, you can still capitalise on the ‘tax bonuses’ available from the government through your own pension contributions. See it as a reduction in your tax bill for the year.

So, choose an appropriate personal pension scheme and set up regular contributions, adjusting them if necessary in light of fluctuating income periods.

Effective tax relief strategies  
It’s important to be confident you have the right steps in place regarding your pension. Consider the following strategies to maximise your benefits.         

• Make sure you contribute at least enough to gain the full match from your employer.  
• Take up a salary sacrifice option if your employer offers one - where you accept a lower gross salary in return for pension contributions, gaining tax relief.
• Review and increase your contributions if possible as you approach retirement.
• Explore taking out a SIPP so you have greater control over your choice of investments than with a standard personal pension.
• Time your withdrawals when you retire to minimise your tax liabilities.    
• Keep informed about changes in regulations so you can adapt your strategy over time.

Understanding tax relief and pensions is critical for effective retirement planning. By taking advantage of tax relief, maximising your contributions and making informed decisions about when to access your pension, you’ll build a firm foundation for your retirement.    

Please get in touch with a member of the team, if you’d like to review your retirement planning and maximise the tax relief on your pension.