Pension tax relief is a major incentive to get people saving for retirement but the majority of people don’t know what it is.
According to an October Opinium survey of 2,000 people on behalf of HL, less than one third of people were able to say they understood how it worked. Others thought it enabled people to take income tax free or claim back tax in retirement. And well over 40% said they simply didn’t know.
This is the hidden hero of pensions and people should be aware so they can make the most of their retirement saving and help shelter them from any nasty surprises.
This article isn’t personal advice. Pension and tax rules can change, and any benefits depend on your circumstances. Remember, you can access money in a pension from age 55 (rising to 57 in 2028). If you’re not sure if an action is right for you, ask for financial advice.
What is pension tax relief?
Basically, tax relief is where some of the money you would have paid in tax goes into your pension. If you’re under 75, you can currently get tax relief on pension contributions at what is known as your marginal rate. This means that if you pay tax in England, Wales or Northern Ireland then a basic rate taxpayer gets relief of 20%, a higher rate taxpayer gets up to 40% and additional rate gets up to 45%.
So, a £100 pension contribution made by a basic rate taxpayer would actually only cost them £80. The same contribution from a higher or additional rate taxpayer would effectively only cost them £60 and £55, respectively.
If you are a Scottish taxpayer then you will pay different rates of income tax with several more thresholds in place. For instance, basic rate income tax of 20% is only payable for incomes between £15,398 and £27,491. The top rate of tax on incomes worth more than £125,140 is 48%.
You can get tax relief on any contributions made up to your annual allowance. This is set at whichever is lowest of £60,000 or 100% of your annual earnings, though you might have a lower allowance if you’re a very high earner or have already taken money out of a pension. Higher and additional rate taxpayers must pay sufficient tax to claim the full 40% or 45% tax relief.
There’s even a process to ‘carry forward’ your annual allowances from the previous three tax years, to boost your contributions. It’s an enormously tax efficient way to make the most of your long-term saving.
Why understanding tax relief is important
Not being aware of how tax relief works can mean you don’t make the most of it.
One key example is understanding how much tax relief you’re receiving and whether you need to act to claim more. If you’re in a salary sacrifice or net pay scheme (where your contribution is made before tax is calculated), then you will receive tax relief on your contribution at the correct rate.
However, if you’re contributing to what’s known as a ‘relief at source’ scheme, then your pension contribution is taken from your after-tax pay. This means you will only get 20% tax relief on your contribution, so if you pay tax at higher or additional rates you will need to claim the extra relief yourself through your tax return.
Some workplace pensions and all personal pensions – like Self-invest Personal Pensions (SIPPs) – are set up under ‘relief at source’ so you need to be aware of this so you can get the tax relief you’re entitled to.
You can also benefit from tax relief on pension contributions even if you aren’t working or earn less than £3,600 per year. You can contribute up to £2,880 per year to your pension, such as a SIPP, and the government will give you tax relief topping it up to £3,600. This applies to your own contributions as well as those made on your behalf.
So, if one partner has made the most of their own pension allowances and has some spare cash, they can use it to bolster the retirement resilience of a non-working partner or even a child through a Junior SIPP.
With a SIPP, as well as getting tax relief, you can also shelter your money from UK income and capital gains tax.