What is pension tax relief?

To encourage you to save for the future, you benefit from tax breaks on contributions you make to your pension. This is at the highest rate of income tax that you pay.

While the Government recently said it has no immediate plans to change pension tax relief, there are no guarantees that relief at the current levels will be around forever.

The following information is based on the tax position for England, Wales and Northern Ireland. Different tax rates and bands apply to Scottish residents.

How does pension tax relief work?

Typically, a basic rate tax payer gets 20% relief and a higher rate tax payer gets 40%. Your pension provider will add basic rate relief at 20% to the amount you pay in to your pension. If you’re a higher rate tax payer, you can claim a further 20% via your self-assessment tax return.

Additional rate tax payers can claim a further 25 % tax relief.

To invest £100 in a pension

Basic rate tax payer

Tax relief

Costs you

Higher rate tax payer

Tax relief

Costs you

Additional rate tax payer

Tax relief

Costs you

How much can I pay?

There is a cap on how much you can pay and receive tax relief on your contributions. This will generally be the lower of your earnings and your annual allowance. The standard annual allowance is £40,000 each year but it could be reduced if your annual income is more than £150,000, or you have already accessed your pension under the new pension freedoms. If you haven’t used your annual allowance in previous years it is possible to pay more than £40,000 in the current year by carrying forward any unused allowance from the last 3 years.

Read our guide: Managing your pension annual allowance.

5 tips to maximise your pension tax relief

1. Pay more now

If you are a higher rate tax payer, you should perhaps consider paying more into your pension now while you know you can benefit from higher tax relief.

Of course, your pension is invested and can go up as well as down and you could get back less than you paid in.

2. Don't forget to claim any higher rate tax relief in your tax return

Some pension schemes offered by employers take pension contributions from your pay before any tax is deducted. This is so that you always get tax relief at your highest possible rate and you don't need to do anything to claim it.

However, if you contribute to a SIPP or personal pension, which may be the type of arrangement offered by your employer, your contributions are paid from your income after tax has been deducted. Your pension provider will add tax relief at basic rate (20%) to the amount going in to your pension pot. But, any higher or additional rate tax relief has to be claimed by your self-assessment. This additional tax relief doesn’t go into your pension but typically reduces the amount of tax you pay in the following tax year.

But, if you don’t claim it you could be settling for relief at 20% and missing out on thousands of pounds worth of additional relief. And if you have failed to claim in the past you can still claim relief for the previous 3 tax years.

For example, a higher rate taxpayer paying £8,000 each year in to their pension will get £2,000 added by their pension provider. They will only receive their extra £2,000 tax relief by completing their self-assessment.

3. Rethink your ISA

From age 55 you can now have unrestricted access to your pension savings. With access no longer an issue, if you are 55 or over you may want to think about moving your ISA into your pension to enjoy tax relief on your savings.

If you are a basic rate tax payer, £100 in your ISA could be worth £125 in your pension due to tax relief. And if you're a higher rate taxpayer, for the same net cost, £100 in your ISA could be worth £166 in your pension thanks to tax relief. Of course your pension fund may be taxable when you take withdrawals from it. But, thanks to the fact you can take 25% of your pension fund tax free, it could still give you more in your pocket than an equivalent ISA if you’re a higher rate taxpayer.

What's more, unlike your ISA, your pension pot is generally outside your estate for inheritance tax.

Read our guide: Passing on your wealth tax efficiently.

To move your existing ISA savings to your pension you will need to have both the earnings and available annual allowance to support the contribution and benefit from tax relief. So, you may need to consider doing this prior to retirement while you still have the income to support a larger than normal contribution.

Before making any decisions, you need to think carefully whether this approach is right for you and your personal tax situation. Should you need access before age 55, keeping it in an ISA may be a better solution.

Of course your pension is invested and the value can go up as well as down and you could get back less than you paid in.

4. Avoid the child benefit tax charge

A pension contribution could help some people retain their child benefit. You may begin to lose child benefit if one family member earns more than £50,000. Child benefit is worth £2,501 (in 2018/19) to a family with three kids, but may be cancelled out completely by a tax charge if the taxable income of the highest earner exceeds £60,000.

Pension contributions reduce the amount of income that is used to assess eligibility. Making a pension contribution to bring your income back down to below £50,000 a year can be a useful way to retain your child benefit and you’ll also receive tax relief on your pension contributions too.

5. Reclaim your personal allowance

A pension contribution can help someone with income over £100,000 a year to retain their personal income tax allowance. The allowance means you don't pay any income tax on the first £11,850 (2018/19) of your income. However, it begins to be withdrawn once your income is greater than £100,000 and there is no personal allowance if your income exceeds £122,000.

A pension contribution reduces the income used to test whether you’re entitled to the personal allowance. Making a pension contribution to bring your income down below £100,000 means you keep your allowance and that you will get 40% tax relief on contributions too.

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The value of investments can go up and down. It’s possible they may be worth less than was invested.

Remember, tax rules and legislation can change and the value of tax benefits depends on your individual circumstances. This information is based on our understanding in April 2018.

Access to impartial guidance

We recommend you seek appropriate guidance or advice before you make any decisions. An adviser may charge a fee for this. You can also get free impartial guidance over the phone or face to face with Pensionwise. Go to pensionwise.gov.uk or call 0800 138 3944. Make sure you understand all your retirement options by reading the Money Advice Service guide – Your pension - it’s time to choose

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