How does pension tax relief work?

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Actively planning ahead and saving as much as you can for your future is a great financial habit to get into. And trying to build up a pension pot might not be as challenging as you think – thanks to pension tax relief.

Here we take you through the basics and benefits of pension tax relief, and how you can make the most of it.

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Pension tax relief explained

In a nutshell, pension tax relief is an extra amount that’s added to your pension contributions. So it effectively means it’ll cost you less to save more into your pension plan.

Although most people get tax relief on their pension contributions, depending on how your pension scheme works (if you’re part of a salary sacrifice or salary exchange scheme, for example) you might get tax benefits in a different way. So do check with your employer if you’re not sure.

The amount of tax relief you get usually depends on the rate of income tax you pay. For most of the UK, this means basic-rate taxpayers (who pay 20% income tax) get tax relief at the same rate. If you’re a higher-rate taxpayer you get 40% tax relief, and additional-rate taxpayers get 45%, but you’ll need to claim back anything over 20% from the government.

If you don't earn any taxable income, you're still entitled to 20% tax relief on your contributions up to the amount you earn. If have no earnings, or earn less than £3,600 in a tax year, you can still get tax relief on contributions up to £2,880.

While income tax is slightly different in Scotland, the effect on your pension contributions is broadly the same. You can find out more about income tax at Gov.uk

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Try thinking of it this way…

If you contribute £80 into your plan, £20 of tax relief will be added to that. Meaning £100 total will be paid into your pension plan.

To get £100 paid into your plan as a higher-rate taxpayer it would cost you £60, or £55 as an additional-rate taxpayer. However you do need to claim anything over 20% back from the government.

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Think about the difference that could make over time

Pension tax relief makes it more tax efficient to save more into your pension plan. And these boosted contributions are then invested with the aim to grow. 

So the more that’s paid into your plan, the higher the overall value of your pot becomes and the more opportunity it has to grow over time. It can have a snowball effect. Although that’s not guaranteed – the value of investments can go down as well as up and you may get back less than was paid in.

Plus some employers will even offer matching schemes, meaning they’ll pay more into your pension plan if you do too. This can all really add up over time and could make a big difference to the amount you will have in the future.

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How tax relief is added to your pension contributions

For most types of pension plans, you'll automatically get tax relief at the basic rate (20%). If you pay tax at the higher rate or additional rate, you might need to claim back anything above the basic rate direct from the government.

Just make sure you do claim that extra amount; while nothing is guaranteed, if you add it to your pension pot it could really make a difference.

Many workplace pension schemes take your contribution from your salary before you pay tax. In this case, your tax relief is automatic and you don’t have to contact the government. Check with your employer if you’re not sure if this applies to you.

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There’s a limit to how much tax relief you can get

Including tax relief, you can normally pay up to £40,000 into your pension plans each tax year, which is your pension annual allowance, or 100% of your earnings, whichever is lower. If you have no earnings, or earn less than £3,600, then you’re still entitled to basic rate tax relief on contributions up to £2,880.

This limit applies to the total amount of contributions made into all of your pension plans in a tax year – including the ones your employer, or any third party, makes on your behalf. 

The good news is that if you haven’t used all of your pension annual allowances in the last three tax years, you can carry them over and use them to pay in more in the current tax year. Remember that you still can’t pay in more than 100% of your earnings.

If you’re on a higher income of £240,000 or upwards, your annual allowance could be reduced to what’s called a tapered annual allowance. So if that applies to you, it’s worth talking this through with an adviser. There’s likely to be a charge for this.

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What to consider if you’re working and accessing your pension savings

If you plan to take some of your pension savings from the age of 55 (rising to 57 in 2028) and keep working, it’s worth knowing that your annual allowance can change when you start to take money from your pension plan.

If you decide to take a flexible income from your plan but want to keep on saving, you might get a smaller annual allowance of £4,000, not £40,000 – and you can’t back-claim any unused allowances.

To find out more, read our article on continuing to work and save into your pension.

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Make sure you’re making the most of pension tax relief

It’s a benefit that makes your pension plan one of the most tax efficient ways to save for your future – so take advantage of it.

You can top-up or increase your contributions to your Standard Life pension plan online or through our mobile app.

For more information on pension tax relief, check out the Money Helper website or try the Which? pension tax relief calculator. It shows you how much tax relief you get based on your pension contributions.

 
A pension is an investment and its value can go down as well as up and may be worth less than was paid in.

Your own personal circumstances, including where you live in the UK, will have an impact on the tax you pay. Laws and tax rules may change in the future.

The information here is based on our understanding in October 2021 and shouldn’t be taken as financial advice. 

Standard Life accepts no responsibility for information contained on external websites. This is for general information only.