How does pension tax relief work?

Everyone’s entitled to tax relief when they pay into a pension, even non-taxpayers. Tax benefits depend on individual circumstances and are subject to change. Here we explain the current pension-related benefits.

In this video, Laura Stewart-Smith, Head of Client Engagement at Aviva, explains more about how pension tax relief works and how it can help boost your retirement savings.

This video is part of The Pensions Playbook. Whether you're watching a full video or a single chapter, you can start wherever suits you.

Your tax relief depends on how much you pay in, your income, and the highest rate of income tax you pay in a tax year. 

For example, for every £100 you put into a personal pension, you’ll get £25 tax relief, giving a total contribution of £125. This is because basic rate tax in the UK is currently 20% (and 20% of £125 = £25). That's all the tax relief available when you're a nil or basic rate taxpayer. Or a starter rate tax payer in Scotland.

If you’re a higher or additional rate taxpayer (in England, Wales and Northern Ireland), or an intermediate, higher or advanced rate taxpayer (in Scotland) and paying into a personal, you can claim back additional tax relief through your self-assessment. You just need to include your pension contributions when you file your return.

Some workplace pensions, known as occupational pension schemes, take your contributions from earnings before tax is deducted. If you’re in one of these schemes, you'll automatically receive all the tax relief you’re due up front – unless you're earning below the personal threshold of £12,570 (or in the government’s National Employment Savings Trust, Nest, as they deduct contributions from earnings after tax just like personal pensions).     

If you’re in an occupational pension and earn below £12,570, HMRC will calculate the tax relief due  at the end of each tax year and send a payment directly to you.

If you're unsure how you get tax relief for your workplace pension, ask your employer.

You can usually put up to £60,000 each tax year in your pension before you incur a tax charge. This maximum amount is known as your annual allowance. This limit applies to the total of your own contributions and any employer contributions paid on your behalf. 

Within the annual allowance it's important to note that you'll only receive tax relief on your personal contributions up to the higher of 100% of your earnings or £3,600 (even if you're a non-earner).

Please note that if you earn more than £200,000 (excluding the value of any pension contributions paid by you or on your behalf) and more than £260,000 (including the value of any pension contributions), the annual allowance can potentially reduce to as little as £10,000.

Remember that the value of your pension can go down as well as up and you could get back less than you’ve paid in.

If you have a defined contribution pension (one in which money paid in by you and/or your employer is invested to provide a pot of money to use at retirement) and you've accessed the money 'flexibly' - meaning you've taken a taxable lump sum or started withdrawing a flexible income - a lower annual allowance of £10,000, called the Money Purchase Annual Allowance (MPAA), will apply to future payments into defined contribution pensions.

The Money Purchase Annual Allowance will not affect you if: 

• You only withdrew your tax-free lump sum and not a penny more
• You were already taking ‘capped drawdown’ before 6 April 2015
• You bought an annuity with your pension savings rather than taking flexible income withdrawals or a taxable lump sum
• You cashed in a whole pension pot of up to £10,000 as a small lump sum (no more than three times in relation to personal pension schemes).

Once the Money Purchase Annual Allowance applies to you, you'll still have an annual allowance of £60,000, but you'll only be able to contribute up to £10,000 of it into defined contribution pensions, with the remainder being available for other types of pension savings (such as defined benefits).

If you’ve already used up your annual allowance for this tax year, you may be able to ‘carry forward’ any unused annual allowance from the previous three tax years. You cannot carry forward any unused money purchase annual allowance.

To carry forward unused allowance from a tax year, you must have been a member of a registered pension scheme at some point in that tax year. People who have been in a scheme in each of the last three tax years but had no pension contributions paid could potentially put in £240,000 in the current tax year.

To get tax relief on such high personal contributions in one tax year, you would have to have earnings of at least the amount you wish to pay in yourself, including any tax relief claimed by the scheme. More likely, the contributions would be paid by your employer.

Investing a bonus payment could be an ideal way to boost your pension fund and make the most of tax relief. Even better, if your employer’s willing to pay it using a bonus sacrifice scheme, you’ll both avoid National Insurance contributions, giving you a little more still in your pension pot.

Did you know your partner could get tax relief if you pay into their pension? The rules are just the same as if they were making payments themselves. It’s another way you could both make the most of the tax benefits of pensions.

With such generous allowances, the question of this tax year or next may not seem important. But there’s no guarantee allowances will always stay this high, so it's worth taking advantage of this allowance while you can.