Tax Relief on UK Pension Contributions Explained
Published / Last Updated on 14/02/2025
To encourage you to save in pensions for retirement for both you and children/grandchildren, the government offers tax relief as an incentive to both you and your employer.
Current Income Tax Bands
- 0% tax on earnings within the personal tax allowance of £12,570.
- Personal tax allowance may be reduced if you have unpaid tax, benefits in kind at work such as a company care or medical insurance or if earnings exceed £100,000 then for every £2 over, your personal tax allowance is reduced by £1.
- 20% Basic rate tax payable on earned income above your personal tax allowance on next £1 and £37,700.
- 40% Higher rate tax payable on earned income on £37,701 to £125,140.
- 45% Additional rate tax payable on earned income above £125,140
Income Tax Relief is usually given at your highest/marginal rate of tax, for example:
- 20% tax relief is granted on personal contributions if you are a non-taxpayer or a basic rate taxpayer.
- Non-earners (including children) can have up to £3,600 pa gross paid into a pension plan including basic rate tax (£2,880 net is paid in and 20% tax relief of £720 is added to this= total £3,600).
- Basic rate tax is payable on taxable earnings above your personal tax allowance up to £37,700.
- 40% tax relief is granted on personal contributions if you are a higher rate taxpayer but only on earnings that are in the higher rate tax bracket.
- E.g., if you earn £60,270 pa, then £10,000 is in the 40% higher rate tax bracket and the balance is in the 20% basic rate tax bracket.
- This means if you make a gross pension contribution of £20,000. £10,000 will attract higher rate tax relief and £10,000 will attract basic rate tax relief.
- 45% tax relief is granted on personal contributions if you are an additional rate taxpayer but only on earnings that are in the additional rate tax bracket in the same way as higher rate tax above.
Employer Contributions Tax Relief
- Employer pension contributions are paid gross into the pension scheme with no tax relief for you personally, but your employer gets tax relief as an allowable expense and offsets the contribution to corporation tax or if self employed or a partnership, then their own business expenses and income tax.
How is Tax Relief Granted on Private Schemes?
- Personal contributions, you pay a ‘net’ contribution into the pension scheme, e.g. £80.
- 20% tax relief is usually granted at source i.e., £20 is added by the pension provider to you pension fund, making it up to £100.
- 40% tax relief is granted by 20% granted at source i.e., £20 is added by the pension provider to you pension fund, making it up to £100 and the 20% (£20) balance of tax relief due is reclaimed by self assessment, in this case meaning you physically paid in £60 (after the tax reclaim, £80 contribution less £20 tax refund = £60) but £100 is in the pension fund.
- 45% tax relief is granted by 20% granted at source i.e., £20 is added by the pension provider to you pension fund, making it up to £100 and the 25% (£25) balance of tax relief due is reclaimed by self assessment, in this case meaning you physically paid in £50 (after the tax reclaim, £80 contribution less £25 tax refund = £55) but £100 is in the pension fund.
- Employer contributions to your personal scheme are paid in gross with no adjustment.
How is Tax Relief Granted on Company Schemes? Net Pay Scheme
- Personal contributions are usually deducted via payroll from your gross paid before income taxes are applied to the remaining ‘Net’ pay.
- This means you have had full tax relief immediately as you only pay income tax on the ‘net pay’ balance after the pension contributions deduction.
- Employer contributions to your personal scheme are paid in gross with no adjustment.
- Gross Pay Scheme
- Some company pension schemes (but not many) offer ‘gross pay’ arrangements, i.e., you pay full income taxes on your gross pay and then a pension contribution is paid from your net pay after all taxes and deductions.
- This means you have not yet had tax relief.
- Tax relief is then granted in the same way as you claim tax relief on Private/Personal pension schemes.
Maximum Pension Contributions
- The maximum both you and your employer can pay into pensions schemes each year with tax relief is the lower of
- £60,000 pa.
- Your gross salary.
- This is known as your Personal Allowance.
- If you do not use up each year’s personal allowance, you can carry forward unused personal allowance tax relief for up to 3 years meaning you could pay in more than £60,000 in a year if you have unused allowances.
- If you pay in more than you are entitled (including carry forward), then you can but no tax relief is due, and you should not claim it. If you do get tax relief or pay in over your personal allowance, you will face tax penalties.
The Future of Pension Tax Relief
It has long been known that HMRC (and indeed both Blue and Red ‘governments’) are keen to revisit retirement, pension savings and tax relief in general.
- 2016 – George Osborne, Chancellor, backed down on moving to a single rate on pension tax relief. Figures were never published but it was thought that Higher Rate and Additional Rate tax relief would be abolished, hitting higher earners and a basic rate of relief increased from 20% to say 25% for all would be introduced.
- This was dropped after the Brexit vote in June 2016 put the UK economy into ‘freefall’.
- 2024 – Labour’s manifesto did not include any mention of tax relief changes, but they did confirm they plan to have a full review of the ‘pensions’ framework.
- Labour’s Pension Framework Review has already started with requiring surpluses in defined benefit pension schemes to invest more in the UK as well as the Pensions Bill with four key drivers:
- Value for money framework – promising better governance and higher returns to boost pots.
- Default ‘At Retirement’ products – pensions schemes will be required to offer a default retirement solution for those not able or unwilling to make choices at retirement.
- Too Many Pension Pots – the average person in the UK moves jobs 7 times during their career, the new Pension Dashboard will help people keep track of them
- Value for Money – for too long many pension savers have suffered higher charges that ‘eat’ into their pension pots. The finance industry already had a ‘value for money’ directive as part of the FCA’s Consumer Duties (under the Conservatives) that started last year, and we expect more under Labour.
- 2025 – Rachel Reeves, Chancellor, needs to raise more taxes if the government is not to break her fiscal rule of not borrowing more to fund government spending.
- The findings of George Osborne’s government departmental research in 2015/16 have not been lost, they are simply on the ‘pending shelf’.
- The Chancellor is clearly not afraid to ‘upset the apple cart’ given the massive hit to unused pension funds by including them in the estate for inheritance tax from April 2027. It is therefore very likely over the next few years that pension tax relief will change.
