How does tax relief work on pension contributions?

Tax relief is a nice extra bonus from the government to help bump up your retirement savings. It is where you receive the income tax you have already paid on the money as an additional payment into your pension.

How does it work?

Whenever you contribute to your pension, be it a regular payment or a one-off, the government gives back the income tax you have already paid on this money. This money is paid straight into your pension, making it as though your payment was made before tax.

How much tax relief will I receive?

The amount of tax relief you receive depends on the rate of income tax that you pay, be it basic rate (20%) or higher rate (40%). So, if you are a basic rate taxpayer then you will receive 20% back as tax relief to make up for the tax you have already paid.

Tax relief and personal pensions

Personal pensions are a type of defined contribution pension where the value of your pot all depends on the money that has been paid in, how well your investments perform and the charges applied by your provider.

Let’s say you have a personal pension, are a basic rate 20% taxpayer and make monthly pension contributions of £80. This is how your pension contributions would look each month with tax relief on top:

Your pension contribution: £80
Basic rate tax relief: £20
The total payment into your pension: £100

Tax relief and final salary pensions

If you have a final salary pension scheme, then tax relief works in exactly the same way as shown above. The difference is that rather than relying on any money paid into your pension to provide an income later in life, with a final salary pension your employer promises to pay a guaranteed income for life when you retire. This income is determined by how long you work for the company and your salary while working there.

Do I get tax relief on employer contributions?

Tax relief is only applied to the contributions that you make. It is not granted for any contributions made by your employer. This is because it’s a way of gifting back income tax that you paid when receiving your wages. You are still getting a bonus from having your employer make contributions on your behalf. This is essentially free money for when you retire.

Do I have to claim tax relief?

Everyone receives tax relief on their pension contributions at the basic rate of 20%. So, if you are a basic rate taxpayer then you don’t need to do anything as this will be arranged by your pension provider. If you are a higher rate (40%) taxpayer you will automatically receive 20% and will need to claim back the rest. You can do this by completing an Annual Self-Assessment form with HMRC or by contacting your local tax office.

Tax treatment depends on your individual circumstances and may be subject to change.

What is salary sacrifice and how does it work?

We’ve explored how you receive tax relief on money you have received in your wages. Salary sacrifice works a little differently. While the idea of sacrificing salary doesn’t sound appealing, in this case it’s actually a good thing. With salary sacrifice your employer offers to reduce your salary by the amount of money you wish to pay into your workplace pension. They then pay your contribution alongside their payment into your pension. In essence, this means that both you and your employer receive tax relief and you don’t have to pay as much National Insurance.