One of the biggest benefits of saving into a pension is you receive tax relief up to the higher of £3,600 or 100% of relevant UK earnings capped at the Annual Allowance (£60,000 in 2024/25).
How do I receive my pension tax relief?
You’ll automatically get 20% basic rate tax relief added to your pension contributions and paid directly into your pension scheme if:
- Your pension provider claims the 20% tax relief on your behalf and adds it to your pension pot, this is known as a ‘relief-at-source’ arrangement. All personal pensions, and some workplace pensions, are relief-at-source pension.
- You’re a higher rate taxpayer, you receive 20% at source but can reclaim an additional 20% tax on their pension contributions for a total of 40% tax relief. Those on the additional tax rate of 45%, can reclaim 25%.
However, those of you on higher or additional tax rate, will need to reclaim the additional tax relief back through your self-assessment or by contacting HMRC directly.
If you’re part of a workplace pension where your pension contributions are deducted.
Example of how pension tax relief works
If you’re a basic rate taxpayer and wanted to make a gross contribution of £100, you would pay £80, receiving £20 tax relief at source. Higher rate taxpayers still pay £80, receiving £20 tax relief at source, and then claim the further £20 through self-assessment. This means the net cost is £60. For those on additional rate, you pay £80, claim £25 with a net cost of £55.
Additional contributions by other people
Other people can also contribute to your pension pot which counts as if you’d made the contribution yourself. Unfortunately, this means your benefactor will not be entitled to any tax relief. You still automatically receive the basic rate tax relief and then claim the higher or additional rate of tax relief on the total contribution.
Limits to relief
You can get tax relief on personal pension contributions up to the higher of £3,600, or 100% of relevant UK earnings capped at the Annual Allowance. The annual allowance is reduced (known as tapering) for higher earners by £1 for every £2 of income over £260,000 (including some pension contributions). Tapering stops when the annual allowance reduces down to £10,000.
If you have a defined contribution pension, once you make a taxable withdrawal you can still contribute to a pension scheme scheme in future and still receive tax relief, but the amount you can contribute reduces. This lower amount, known as money purchase annual allowance, is set at £10,000 pa.
Pension carry forward
If you haven’t used your full annual allowance over the previous three tax years, you may be able to use unused Annual Allowance to make a one-off, large pension contribution, or make smaller payments over three years. This is known as ‘carry forward’ enabling you to enjoy extra tax relief on pension contributions above £60,000, using the earliest available allowance first. The maximum total gross contribution available is therefore £200,000 subject to certain criteria being met.
Higher Earners: using your pension to avoid the 60% tax trap
Once you’re earning £100,000 or more, the £12,570 personal allowance slowly tapers down (reduces), currently at a rate of £1 for every £2 you earn above £100,000. Once you’re earning £125,140 or more, you don’t receive any personal allowance. Therefore, if you’re earning between £100,000 and £125,140, the tapering of the personal allowance means you could end up paying 60% tax.
Example: for every £100 of income between £100,000 and £125,140, you only take £40 home – £40 is deducted in Income Tax, while another £20 is lost by the tapering of the personal allowance. This amounts to a 60% tax rate.
One of the quickest and simplest ways to bring your taxable income below the threshold is to pay more into your pension before tax year-end. This is a win-win, since you reduce your tax bill and boost your retirement fund at the same time.
Tax Free Lump Sum
You can withdraw up to 25% of your pension tax-free from your pension at retirement; this is capped at £268,275 over your lifetime.
Inheritance Tax & your pension
One negative relating to tax and pensions announced in the Autumn Budget, is that from April 2027, any unused pension pots and death benefits in estates worth over the threshold of £325,000 (or £500,000 for qualifying estates) will be subject to Inheritance Tax. However, if your estate and pension are passed on to your spouse or civil partner, this will still be exempt from Inheritance Tax.
It’s important to caveat at this stage that the Government is currently consulting on pension Inheritance Tax as detailed in their open consultation paper published on 30 October 2024. You can view this here.
Tax rules are complicated, and the goalposts often move. By checking your financial situation on a regular basis, you can take advantage of any tax benefits are available to you personally. Why not get in touch to see if we can help?
The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.
Any tax relief over the basic rate is claimed via your annual tax return.
Sources
Gov.uk: ‘Tax on your private pension contributions’ 22/11/2024
Commonslibrary.parliament.uk: ‘Pension tax relief: The annual allowance and lifetime allowance’ 14/10/2024
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SJP Approved 28/11/2024