Pensions tax relief – How it works
Pensions tax relief – How it works
For decades now pension tax relief has been the cornerstone of policy for successive governments to promote saving for retirement and to reduce dependence on the state pension. Alongside specific initiatives, such as employer auto-enrolment obligations, most workers will now have some kind of pension nest egg.
Here, we explore all the key aspects of pensions tax relief and how it may affect you. If you are looking for help or advice on pensions tax relief or any other pension tax issue please contact Chris Holmes or Helen Jones.
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The basic rules
Contributing to a pension has always been a tax-efficient method to save towards retirement. If you are UK resident and under 75, you will be eligible for tax relief on contributions into your pension. In order to get full tax relief, the amount you can pay into your pension is restricted to the higher of:- £3,600 gross (£2,880 net)
- The amount of your relevant UK earnings; but to a maximum of your annual allowance for the year (from 6 April 2023, usually £60,000 - but see below).
Most contributions to personal pension schemes are paid net of basic rate tax relief (via a relief at source scheme), so the only additional relief is through a claim on the self-assessment tax return for higher rate relief. This extra tax relief is given by extending the basic rate band by the gross amount of the pension contribution.
In contrast, employees making contribution into their employer’s occupational scheme will receive full relief at source as the contribution will be paid out of gross income before tax is calculated on the balance (via a net pay scheme). This applies equally to salary sacrifice arrangements.
Tax relief extends to the growth in the value of pension savings, as the pension fund itself will not pay tax on its investment returns.
Having effectively paid monies into the pension scheme and grown the fund tax free, it is then usually possible to extract 25% of the ‘pension pot’ (up to the lifetime allowance – see below) as a tax-free lump sum when you commence drawing down retirement benefits currently from the age of 55 (although there are plans to increase this age to 57 from 2028).
The remaining 75% of your pension pot will usually be taxed through PAYE as and when you receive it at your marginal rates of income tax, which will depend on your level of all other taxable income in that tax year.