How Do I Claim Pension Tax Relief?

Article Summary:

Taxpayers can earn tax relief on their pensions so that some of the money they would have paid in tax on their earnings go into their pensions pot rather than to the government. Tax relief is paid on your pension contributions at the highest rate of income tax you pay.

Pensions are a great way to save for retirement for several reasons. Apart from giving you a more comfortable retirement, the government will sometimes pay you to save. This means that the government gives you free money just for having a pension in place. Pension tax relief is offered by the government in the UK. It is similar to how 401(k)s and IRAs provide tax savings when you save for retirement. Read below to find out more about how you can claim your pension tax relief. If you were looking for relief from tax debt in the United States, find out how to get tax relief help here.

What is Pension Tax Relief?

Pension tax relief allows UK taxpayers to claim private pension contributions worth up to 100% of their annual earnings. It’s money you can get back from the government to help you increase your retirement savings. If you, your employer, or your spouse contribute toward private pension contributions, you will want to learn more about pension tax relief come tax season.

This article refers to a tax relief program that is available in the United Kingdom. If you are looking for relief from tax debt in the United States there are multiple programs you can apply for.

As you invest into your pension, the government will give you back taxes that you have paid and put them into your pension to help you increase your retirement savings. Since you’re getting tax dollars back, it is known as a form of tax relief. This means some of the money that would have gone to government spending through taxes goes into your pension instead.

How much pension tax relief can you claim?

Your income tax will depend on where you live and your income. The tax rate for relief that you will qualify for is directly related to the income tax that you pay annually. This means that your tax relief amount is directly proportional to your income.

The amount of tax relief that you will get will depend on how much income tax that you pay each year. If you qualify for the basic rate, then you as a taxpayer will pay 20% income tax on average, so you can expect to get a 20% pension tax relief. If you qualify for the higher rate, taxpayers pay 40% income tax, so they get 40% in pension tax relief. Additional-rate taxpayers get 45% tax relief to reflect the 45% income tax that they pay. Since your income can change over time, it’s important to know annually which tax bracket you will fall into.

There is one exception to this. Lower-income taxpayers who pay 19% in income tax can claim 20% for their tax relief on their contributions.

How to claim pension tax relief

The way that you are able to claim your tax relief on pension contributions will depend on your employer. You will first want to check with your HR department to see which pension scheme that your employer uses since there are two main ways pension tax relief is applied.

Net pay

Net Pay is a pension scheme used by some workplace pension providers. When your company uses net pay, it means that your pension contributions are taken from your salary before income tax is deducted. In this case, your pension then claims back tax relief at the highest income tax rate on your behalf.

In other words, the income tax you pay is deducted after you have paid money into your pension, making the tax amount you owe lower.

It’s a great setup if you are a higher- or an additional- rate taxpayer. The full amount of tax relief received gets automatically applied for them without completing a tax return.

Tax relief at source

Relief at Source pension scheme is the more common way for claiming pension tax relief on your pension contributions. It generally applies to personal pensions and Self Invested Personal Pensions (SIPPs), as well as some workplace pensions also.

The way it works is you pay income tax on your earnings like normal. Then, you make contributions to your pension. Your provider can then claim tax relief from the government and adds it to your pension for you.

If you are a basic-rate taxpayer, you don’t need to do anything else beyond this. Your pension provider will do most of the work for you when it comes time for you to get tax relief. If you are a higher- or additional-rate taxpayer, you need to claim the rest of the tax relief on your pension contributions yourself. That’s because your provider will only do up to the 20% mark. Sometimes, your employer will contribute on your behalf beyond the 20%, but this is expected to be done by the individual.

Do I qualify for tax relief if I don’t pay income tax?

Yes. Even if you don’t pay income tax in a given year because you don’t earn enough to pay taxes, you can still claim the 20% basic tax relief for their pension contribution.

The exception to this is if you save a workplace scheme and your employer already has a net pay arrangement in place. If you don’t have any earnings at all, you are still able to pay up to $3,000 annually into a pension, and you will receive basic-rate tax relief.

This rule applies to children as well. So if you are able to afford it, you can start a pension for your child, and they will enjoy the long-term benefits from a young age. It’s a great strategy to help save for children who have a long investment horizon ahead of them to give the money ample opportunity to grow. However, since pensions do have a maximum allowable amount before taxes, you should consult with a finance professional before setting this retirement option up for your children.

What happens to tax relief once I access my pension?

You are able to keep saving into your pension, even after you have begun to withdrawal your money. With this being said, the amount you can contribute and still claim as tax relief on pension contributions will drop once you take funds out of your pension for use.

In most cases, once you begin taking money out of your pension, you trigger the Money Purchase Annual Allowance (MPAA), which replaces the annual allowance. The MPAA makes the amount of money that you pay into your pension each year drop from $40,000 to $4,000. This means you can only pay up to $4,000 annually in your pension and receive pension tax relief.

Will I take a tax penalty when I make pension withdrawals?

Even though you are able to enjoy tax relief when you pay more money into your pension, you should expect taxes on your pension withdrawals. When you take money out of your pension, it counts as earned income for the year and becomes subject to income tax.

With this being said, however, that once you are at least 55 years of age, you can take 25% of your pension fund tax-free. It’s called the Pension Commencement Lump Sum. Despite what the name implies, you don’t have to take it all at once as a lump sum payment. You can take the 25% in smaller payments as well. In these instances, once you reach your 25% amount withdrawn, the remaining 75% will be tax at your rate of income.

If you need to access your pension before you are eligible to do it at age 55 and don’t meet the early access rules, then you will pay a steep 55% tax penalty on anything that you withdraw. That’s why it is important to get professional advice before accessing your pension if you need to access your funds early.

What is the limit on how large a pension can be?

The limit on how much you can claim toward pension tax relief is currently £1,073,100 (approx $1,485,000). This is called your lifetime allowance. However, there are ways to limit what contributions count toward your lifetime allowance. What counts towards your allowance depends on the type of pension pot you get. So, it’s a good idea to talk to your pension provider and ask for details on how much of your lifetime allowance you’ve used. If you have more than one pension scheme, add what you’ve used in all pension schemes you belong to.

Anything in excess of your lifetime allowance can be taxed at 25% when you start withdrawing from your and 55% if you take a lump-sum payment. Pension tax relief is a great tool, but make sure you work with a financial professional to choose the best strategy for you.

Key takeaways

  • Pension tax relief is a program by the UK government that helps you save for retirement.
  • How much tax relief you can get will depend on how much money you made for that tax year.
  • There are two ways you can claim tax relief: Net Pay and Relief at the Source.
  • There is a lifetime limit to how much you can claim in pension tax relief. Consult with your pension provider for more details.

Bottom Line

Pension tax relief is a powerful tool that should be incorporated into your personal financial strategy. It can give you extra money now and help set yourself — and your kids — up for financial success down the road. Qualifying for pension tax relief isn’t difficult. Just make sure to always consult with a financial professional, especially before taking any pension payments.

Article Sources
  1. Tax relief for pension contributions (UK) – GOV.UK
  2. Workplace pensions and tax relief– Nidirect.gov
  3. Free tax help – SuperMoney