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Tax relief on pension contributions

A pension scheme is essentially a type of savings plan to help you save money for later life.  It also has a favorable tax treatment compared to other forms of savings. This blog will discuss how putting money into a pension is a tax-efficient form of saving.

When you save into a pension, the government likes to reward you for saving for your future by granting you tax relief.  This means that some of the money that you would have paid in tax on your earnings goes into your pension pot rather than to the government. Tax relief is paid on your pension contributions at the highest rate of income tax you pay, so basic-rate taxpayers get 20% pension tax relief, higher-rate taxpayers can claim 40% pension tax relief and additional-rate taxpayers can claim 45% pension tax relief. To illustrate this, if you are a basic-rate taxpayer and were to contribute £100 from your salary into your pension, it would actually only cost you £80. The government adds an extra £20 on top, which is what it would have taken in tax from £100 of your salary.

The government puts a limit on the amount of pension contributions on which you can earn tax relief, which is called the pensions annual allowance. This has been set at £40,000 for the tax year 2019/20. Any contributions you make over this limit will be subject to income tax at the highest rate you pay.  You can however carry forward any unused allowances from the previous 3 years provided you were a member of a pension scheme in this time period.

Under workplace pension schemes there are three different ways to receive tax relief on contributions.  The first is if your employer deducts your contributions from your pay before deducting tax from your pay. This is called a net pay arrangement, and means you receive tax relief at the highest rate of tax that you pay. 

The second way is called relief at source, and this is when your employer takes your contribution from your net pay (after tax has been deducted but before they pay you) and pay this to your pension provider on your behalf. This is the most likely method if you are part of a group personal pension or other type of personal pension schemes. The pension provider then claims back basic rate tax at 20% from HMRC and adds this to your pot. Using the same figures as in the example above, if your employer has deducted an £80 contribution from your net pay, the pension provider will claim back a further £20 so that the gross contribution of £100 is paid into your pension. Higher-rate tax payers can then claim additional tax relief from HMRC either through Self-Assessment or by adjusting your tax code. Relief at source also applies to all personal pension schemes, including private pensions with an insurance provider or Self-Invested Personal Pensions (SIPPs). Investments in SIPPs grow free from Income Tax and Capital Gains Tax.

The third way is if you’re paying pension contributions through a salary sacrifice arrangement agreed with your employer. This is treated as an employer contribution, with the same effect for you as receiving tax relief but also with an additional saving on National Insurance contributions.

This article has outlined the different ways in which you can receive tax relief on your pension contributions.  FKGB Accounting are on hand to provide professional advice and assistance in all areas regarding pension contributions, for both employees and employers so please contact us if we can help.