Pensions offer a range of tax benefits and are a tax-efficient way to bolster your savings.
To encourage pension saving, the government provides tax pension benefits, in the form of a top-up on your contributions. While some rules limit this benefit, it’s relatively straightforward for the average person to understand.
This simple guide gives you all the information you need to know about your pension and the tax affecting it:
What’s the Tax Relief on Pension Contributions?
Saving into a personal pension offers you tax relief on your contributions. If you’re younger than 75 and are a UK resident, you are eligible for tax relief on your pension contributions.
For every tax year, you are eligible for up tax relief on contributions to the value of up to 100% of your annual salary or £40,000. This limit includes the top-up added by the government. If you don’t earn a salary, the maximum contribution eligible for tax relief is £3,600.
For every £4 a basic rate taxpayer saves into a pension, the government adds £1 tax top-up.
All taxpayers will receive 25% pension tax relief. However, higher rate and additional rate taxpayers can claim further tax tops. Tax relief can only be claimed for the last 4 years.
What’s the Tax Relief on Company Contributions?
A workplace pension is a fund set up by your employer. All employers are legally required to provide workplace pension under Auto-enrolment regulations. These regulations also require your employer to make contributions to your fund if you are:
- Classed as a worker
- Older than 22
- Paid a yearly salary of £10,000
- Working in the UK
As an employee, you will pay a percentage of your salary directly to the workplace pension scheme. Your employer will also pay a percentage contribution. Although the employer contributions don’t count toward tax relief, it will still add to the total value of your pension pot.
Pension Tax Relief on Salary Sacrifice
Your employer may allow you to pay your pension contributions through salary sacrifice, where you reduce your income by the amount you would have put towards your pension. The employer then pays the total contribution on your behalf. You will not be able to claim for tax relief on a salary sacrifice payment, as your income has been taxed at a lower amount.
However, you will save on National Insurance contributions because of the lower salary.
What Amount Can I Contribute to My Pension?
While you should contribute as much as you can towards your pension savings, there is a limit to when it comes to contributions.
You only get tax relief for up to £40,000 of pension contributions, or 100% of your annual income. This amount includes tax top-up from the government.
If you earn below £3,600, or you don’t have an income, you can claim tax relief on contributions up to £3,600.
What Does This Mean for You?
You can save as much as £2,880 as well as the 25% tax top-up.
There is also a cap on how much you can contribute to your pension pot during the tax year, which stands at £40,000. This limit includes your contributions, employer contributions and tax top-ups. Should you put away more than this, you’ll be liable for an annual allowance charge, which taxes you on the amount over the annual allowance.
High-income earners do have a tapered allowance, which comes into effect if you earn more than £240,000, including pension contributions. For every £10,000 you earn over the £240,000, your allowance is reduced by £5,000.
Carry Forward Annual Allowance
If you’ve gone over your annual allowance in pension contributions for the year, you may be able to use some of your unused allowances from past years. You are allowed to carry forward allowances for up to three years, but you must be a member of a pension scheme in those years.
The limit based on your yearly income still applies, and you could still have a cap based on your annual earnings. Employer contributions are not limited by earnings but must pass the “wholly and exclusively” test.
Money Purchase Annual Allowance
This allowance applies once you begin drawing down the taxable cash from your savings fund and includes a restriction on how much you can contribute to your pension. This allowance currently stands at £4,000. If you exceed the annual allowance limit, you’ll have to pay a tax charge based on your income tax rate.
There is a lifetime limit on the amount of pension you can draw before new tax rules come into effect. A lifetime allowance covers how much you can save into a pension pot without triggering a hefty tax charge at retirement. The current cap is £1,073,100 but may increase in years to come.
If you go over this limit, you have to pay in whenever you access the excess benefits from your pension pot. The charge will be 25% if it’s paid as a pension but will jump to 55% if you take a payment in a lump sum. Standard income tax will be added.
But on The Upside
If you have a pension over £1 million, you may be eligible for protection1 from the reduction in lifetime allowance.
When Can I Remove Money from My Pension?
You’ll have access to your personal or workplace pension from age 55. This age limit may increase to 67 in 2028. Your state pension can be claimed in your late 60s.
Your pension is supposed to support you during your retirement and delaying drawing from your funds could allow you to keep your funds for later in life. Should you choose to continue working when you reach 55 or delay taking your pension, you could boost your income for your retirement years.
Did You Know?
The only times you will be able to claim your pension earlier is if you experience poor health and are given a life expectancy of less than a year or are no longer able to work.
Pension Drawdown Tax
Even though a pension is a very tax-efficient way of saving, you will still have to pay some income tax on it. The first 25% of your pension can be withdrawn tax-free. This is irrespective of how large your fund is. However, if you remove more than 25%, you will have to pay pension drawdown tax.
When Are Pension Lump Sums Taxed?
Often, the first 25% of a pension is taken as a tax-free lump sum. The remaining funds will be taxed regardless of if you take it as a lump sum or smaller payouts.
The government views a pension the same as other incomes, and you will be charged your usual rate of income tax once past your tax-free allowance.
If you’re earning another income, it might be in your best interests to carefully consider when you take lump-sum withdrawals, as well as how much your withdraw, you these could put you in a higher tax bracket.
Some pensioners qualify for an income-related benefit called Pension Credit2. This benefit consists of Guarantee Credit and Savings Credit.
If your weekly income is less than £173.25 per person, Guarantee Credit offers you a top-up. Savings credit is an additional payment for those who have put away some money towards retirement, such as a pension. You won’t pay tax on Pension Credit.
How Do You Maximise Your Tax Relief?
Make sure you’re getting the most tax relief possible. You will always get a 25% tax top-up from the government, but if you’re on a higher tax rate or are an additional rate taxpayer, make sure you claim the further tax relief you’re entitled to in your Self-Assessment tax return.
Carry Forward Your Annual Allowance
If you’re likely to go over your annual allowance during this tax year, investigate if you make use of an unused allowance from the last three years. Allowances can be carried forward for three years as long as you were a registered pension scheme member during the period. Remember, your annual income limit is still in place
You will only be able to contribute £40,000 for the year, even if your annual salary is £50,000.
However, if you only paid in £25,000 to your pension pot last year, you could claim the £15,000 in unused annual allowance. This would enable you to pay in the extra £10,000 and receive your tax top-up.
Limited Company Contributions
If you have a limited company, you can use the company to make employer contributions to your pension pot. These are considered allowable business expenses and can be offset against the company’s corporation tax bill.
Employers don’t pay National Insurance on pension contributions, so you would be able to save around 14% on these.
Got Questions? Check These First
How does inheritance tax affect my pension?
Pensions fall outside your estate and don’t affect your inheritance tax threshold. There will be some conditions that apply to your pension after you die, such as how old you are and what type of pension plan you have.
How Can I Maximise Tax Relief on My Pension?
You are entitled to a 25% tax top-up on your pension savings, from the government. However, if you’re on a higher tax rate or are an additional rate taxpayer, you may qualify for further tax relief in your Self-Assessment tax return.
Can I Carry Forward My Annual Pension Allowance?
You can carry forward your unused annual allowance for three years, as long as you were a registered pension scheme member during the period. However, your yearly income limit will still be in place.
What's Pension Drawdown Tax?
You are allowed to withdraw the first 25% of your pension, tax-free, irrespective of how large your fund is. If you withdraw more than 25%, you will be taxed. This is called pension drawdown tax.
Your pension offers you a tax-efficient way to save for your retirement. Make sure you’re getting the most from tax relief programmes available to you, to ensure you have a healthy pension pot come to your retirement.