You’ll often pay Income Tax on money you receive. But if you put that money into a pension, the tax you would normally pay is usually added to your pension instead. This is called tax relief and means your savings are usually boosted by 20% or more, depending on your rate of Income Tax. It’s one of the best things about saving into a pension, as the government is effectively paying into your Pension alongside your contributions.
In many cases, you won’t need to do anything as your employer or pension provider will apply tax relief automatically for you. But you will usually need to claim tax relief yourself if you don’t earn enough to pay Income Tax or pay Income Tax at a higher rate than 20%.
Example: If you pay Income Tax at 40%, you can claim an extra 20% in tax relief. This means a £100 contribution into your pension will cost you just £60, as your pension provider has claimed £20 in tax relief and you’ve claimed another £20 back.
You’ll need to claim every tax year you’re eligible and can usually backdate a claim for the last three tax years. You’ll either receive the extra tax relief as a:
- refund at the end of the tax year
- change to your tax code so less tax is taken off your future income
- reduction in your tax bill, if you owe HMRC tax.
If you’re a non-taxpayer (or pay the 19% Scottish starter rate) you’re entitled to keep the 20% tax relief as long as you don’t contribute more than you earn. If you earn less than £3,600 a year, you can get tax relief on pension contributions you make up to £2,880 each tax year.
Each tax year until you’re 75, you can usually get tax relief on all your pension contributions up to the amount you earn or your Annual Allowance – this is £60,000 for most and covers all payments into your pension, including any from your employer. If you earn under £3,600, you can get tax relief on up to £2,880 of your pension contributions. Pension contributions made after age 75 are not eligible for tax relief.
Example: If you earn £25,000 a year, you can usually pay up to £25,000 into your pension without paying tax (£20,000 of your money and £5,000 in tax relief). If you did this, your employer could contribute another £35,000 tax-free.
If you pay into your pension using salary sacrifice, your contribution is treated as being made by your employer. This means you don’t get tax relief in the standard way. Instead, as you have given up a portion of your wages, you’ll pay less Income Tax and National Insurance by having a lower salary – often making your take home pay higher. Your employer will usually pay less National Insurance contributions too, so might add some or all of this saving to your pension contribution.
If you run your own limited company, you can usually decide which payments into your pension are made as:
- employee contributions from your salary
- employer contributions from your company.
Employer contributions can be deducted as a business expense
Employer contributions do not qualify for tax relief, but they can usually be deducted as a business expense to reduce the amount of corporation tax you need to pay. This is allowed as long as the employer pension contributions are ‘wholly and exclusively’ for business purposes, which typically means they’re a reasonable amount for the work being done. For example, consistent amounts are used for any staff doing similar jobs and pension contributions are not higher than annual profits.
