Pension tax relief has been boosting pension pots for 100 years. Over your working life, it’s an incentive that can add thousands of pounds to your retirement savings. While incredibly valuable, research suggests many high earners are still missing out on their full tax relief entitlement.
Pension tax relief has evolved since it was introduced in the Finances Act 1921, but it still serves the same purpose. The government introduced tax relief to encourage more people to save for their retirement. Some of the money you pay in Income Tax is added to your pension, where it’s often invested to provide an opportunity for it to grow further.
It’s an incentive that cost the government £41.3 billion in the 2019/20 tax year, according to HMRC figures. This figure has increased in recent years as more workers save for retirement under the auto-enrolment scheme, with average annual contributions increasing by £600 between 2017/18 and 2019/20.
How much is tax relief worth?
Tax relief can boost your pension, and analysis by Aegon suggests it could add thousands of pounds to your retirement savings.
The analysis found that a basic-rate taxpayer who starts contributing £100 a month from take-home pay from the age of 22 could have a pension pot worth £354,600 at 68. Of this, around £70,900 would be from pension tax relief. The figure assumes the worker increases their pension contribution with earnings growth of 3%. It’s a pension boost that means workers could have far more flexibility around when they retire and the lifestyle they’ll enjoy.
As tax relief is paid as your nominal Income Tax rate, higher- and additional-rate taxpayers can benefit even more from the incentive. Yet, research suggests that many high earners are missing out on their full tax relief entitlement.
£2.5 billion unclaimed pension tax relief between 2016/17 and 2018/19
According to PensionBee, over 1.5 million high earners failed to claim an estimated £2.5 billion pension tax relief between the 2016/17 and 2018/19 tax years. The research suggests that around 80% of higher-rate taxpayers and 53% of additional-rate taxpayers fail to claim their full pension tax relief.
It’s an incentive that’s easy to overlook or assume that the tax relief you’re entitled to is automatically added to your pension.
If you’re a basic-rate taxpayer, your pension provider will often claim the tax relief you’re entitled to on your behalf. However, this isn’t always the case, so you should check you’re receiving tax relief on your contributions.
However, if you’re a higher- or additional-rate taxpayer, your provider will claim the first 20% of tax relief only. To receive the full 40% or 45% you’re entitled to, you need to complete a self-assessment tax return, even if your tax is usually handled via PAYE.
Completing a tax return can seem like a chore, but it can significantly cut your tax liability and help your income go further. You can usually complete the form online, where you’ll need to state the exact amount you’ve contributed to your pension.
How much pension tax relief can you claim each tax year?
Pension tax relief is a valuable incentive to save for retirement, and there are limits on how much individuals can claim each tax year. It’s important to keep these in mind, as exceeding thresholds could mean you face a higher tax bill than expected.
- The Annual Allowance: This is the limit on the amount of pension contributions that you can earn tax relief from in a single tax year. For the 2021/22 tax year, the Annual Allowance is £40,000 or 100% of your annual income, whichever is the lowest. It’s important to note that the Annual Allowance is made up of all pension contributions, including those made by you, your employer, and any third party, such as pension tax relief. If you’re a high earner, you may be affected by the Tapered Annual Allowance.
- Tapered Annual Allowance: If you’re a high earner, your Annual Allowance may be lower. For the 2021/22 tax year, if your threshold income is more than £200,000 or your adjusted income is more than £240,000, you’ll be affected by the Tapered Annual Allowance. You lose £1 of Annual Allowance for every £2 that exceeds the threshold. Under these rules, your Annual Allowance can fall to as low as £4,000. It can be difficult to understand how much you can tax-efficiently contribute to your pension under the Tapered Annual Allowance. If you’re unsure or have any questions, please contact us.
- The Money Purchase Annual Allowance (MPAA): If you’ve already accessed your pension to take an income, the amount you can pay into your pension tax-efficiently may fall. Under the MPAA you can add up to £4,000 each tax year and still get tax relief.
If you haven’t used your full Annual Allowance in previous years, you may be able to increase pension contributions. You can carry forward unused allowance from the previous three tax years.
Making the most of pension tax relief can help set you on the right track for the retirement you want. If you need help understanding your pension, from how to claim all the tax relief you’re entitled to, or whether you’re saving enough for your retirement plans, please contact us.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investments (and any income from them) can go down as well as up, which would have an impact on the level of pension benefits available.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.
