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One of the great things about saving into a pension is that the government effectively pays you to do it. This is because when you contribute to a pension, the government redirects some of the tax you would expect to pay on your earnings into your pension. Even if you don’t pay tax, this pension tax relief can still usually be claimed as an incentive for you to save into a pension.
How does pension tax relief work?
How much tax relief you get depends on how much income tax you pay:
- Basic-rate taxpayers pay 20% income tax, so get 20% pension tax relief.
- Higher-rate taxpayers pay 40% income tax, so can claim 40% pension tax relief.
- Additional-rate taxpayers pay 45% income tax, so can claim 45% pension tax relief.
This means to pay £100 into a pension, it costs a basic-rate taxpayer £80, a higher-rate taxpayer £60 and an additional-rate taxpayer just £55.
Income tax bands in Scotland are different, but the tax relief applied still tallies with the rate of income tax you pay. The exception is starter-rate taxpayers who pay 19% income tax but get 20% tax relief back on their pension contributions.
How much tax relief can I claim on pension contributions?
The government limits the amount of pension tax relief you can earn in a year. How much you can contribute into a pension and receive tax relief is known as your annual allowance. This limit is currently set at the lower of 100% of your earnings or £60,000.
Higher earners with an adjusted income above £260,000 may get a reduced annual allowance.
If you have started accessing your pension, your allowance is usually set at £10,000 a year.A cap on the level of pension benefits you can build up overall without a tax charge – known as the lifetime allowance – was abolished in April 2024. It has been replaced by new allowances – the lump sum allowance, the lump sum and death benefit allowance and the overseas transfer allowance.
How is pension tax relief claimed?
You can receive pension tax relief in two ways – through net pay or relief at source. An employer can use either option in relation to the workplace pension that they offer, but relief at source will always be used for a personal pension or SIPP that you have set up yourself.
Net pay
The net pay method means your pension contributions are taken from your salary before income tax is deducted. Your pension scheme then claims tax relief back at your highest rate of income tax on your behalf.
This means your income tax is deducted after you have paid money into your pension, so the amount of tax you pay overall is reduced.
This makes life easier if you are a higher- or additional-rate taxpayer, as the full amount of tax relief you are entitled to will be applied automatically, without having to approach HMRC or complete a tax return.
One problem with the net pay system is that lower earners who don’t pay income tax might not receive tax relief top-ups on their contributions.
Tax relief at source
Receiving tax relief at source involves you paying income tax on your earnings as normal. This means that when you make a contribution into your pension, tax has already been deducted from the amount you pay in. Your pension provider then claims 20% tax relief directly from the government, which is added to your pension.
If you are a basic-rate taxpayer, you don’t need to do anything else. However, if you are a higher- or additional-rate taxpayer you’ll need to claim the additional tax relief you are owed yourself.
Lower earners who don’t pay income tax will also get tax relief on their pension contributions under a relief-at-source arrangement.
How to claim higher-rate tax relief on pension contributions
If you are a higher-rate taxpayer who needs to claim extra pension tax relief yourself, you can do so when you file your self-assessment tax return or you can contact HMRC separately.
If you are an additional-rate taxpayer, you have to fill out a self-assessment tax return to claim your extra tax relief.
Do I get pension tax relief if I don’t pay income tax?
If you don’t pay income tax, either because you don’t earn enough (under £12,570 in the 2024/25 tax year) or because you are not working, you are still allowed to claim 20% basic tax relief on pension contributions.
You can claim tax relief on 100% of your income as long as it doesn’t exceed £60,000 a year.
If you don’t have any earnings at all, you can pay up to £2,880 a year into a pension and you will receive the basic-rate tax relief, taking your pension contribution up to £3,600. As this rule applies to children too, if you were to set up a pension for your child and contribute into it, the tax relief that they receive could help them build a pension pot before they even start work.
These are very general rules however, and the rules applicable to you can be very different depending on the level and type of income you personally receive. We strongly suggest you seek professional tax advice or financial advice if you are slightly unsure or have a complex income arrangement as you could miss out on or be ineligible for tax relief on payments you make into your pension.
» MORE: Setting up a pension for your child
Net pay tax relief and having a low income
Where you may not get pension tax relief if you don’t pay income tax is if your employer uses the net pay system of tax relief for their workplace pension. This is because the net pay arrangement involves you receiving tax relief as a result of a reduced tax bill, which you don’t have if you pay no tax.
New rules came into effect in April 2024 that means people affected by this anomaly could be entitled to a ‘top up payment’ equal to the tax relief they would have got if they were in a relief at source scheme. HMRC should identify these people at the end of the relevant tax year (for example, April 2025 for 2024/25).
Alternatively, if you’re affected by this, you could suggest to your employer that they might make up the amount you are missing out on through a higher employer contribution or switch to a different scheme that uses the relief-at-source method. However, they are under no obligation to do so if they don’t want to.
What is the Money Purchase Annual Allowance?
You can keep saving into your pension even after you have started making pension withdrawals, but the amount you can contribute, and on which you can still claim tax relief, usually drops significantly.
In most cases, once you start taking money out of a defined contribution pension you trigger the Money Purchase Annual Allowance (MPAA), which replaces the annual allowance. This sees the amount of money you can pay into your pension each year and receive tax relief fall from a maximum of £60,000 to just £10,000. The rule was introduced in 2015 to prevent people aged 55 or over taking money out of their pension and reinvesting it to claim further pension tax relief.
However, the MPAA does not apply when you take a tax-free cash lump sum and either move your fund into pension drawdown and do not take an income, or buy a non flexible lifetime annuity. Cashing in smaller pensions worth under £10,000 might also be exempt.
» MORE: Your options for cashing in your pension
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Dive even deeper
QROPS Explained: Transferring a Pension Overseas
Guaranteed Minimum Pension Explained – What is GMP?
