Pension tax relief

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‍Before diving in, it’s important to understand that pension and tax rules can and do change. The below guide is based on our understanding of UK pension and tax rules as of 26 November 2021. Any tax treatment depends on your individual circumstances. 

You also need to be comfortable with the fact that the value of your investments can fall as well as rise, so you might get back less than you originally invested.

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What you will learn:

• How pension tax relief works 
• How much can you put in a pension 
• How much tax relief you’ll get 
• How tax relief is paid to you 
• Pension tax relief FAQs

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What is pension tax relief?

Pension tax relief is a bit like a top-up. For most of us, each time we pay into our pension (known as a pension contribution), the government adds money too. It does this through tax relief.

Pension tax relief can be a slightly weird, wonderful and not to mention complex world. 

Where possible it’s best to get in, get the information you need and get out. 

We’ve spent the time sifting through the rule book to help you do just that. 

‍When it comes to getting tax relief on pension contributions there are a few key things you need to know:

1. How much money you can put in a pension and get tax relief 
2. How much tax relief you’ll get
3. How you’ll get the tax relief 

The UK government sets limits on how much we can each contribute to a pension and get tax relief. 

They do this because while pension tax relief plays a crucial role in boosting our savings for later life and retirement, it’s an expensive game for the government. 

Deciphering these limits is not for the faint-hearted, so we’ve created a framework that should help most of us contribute to a pension in the most tax-efficient way. 

Each year you can pay up to 100% of your annual earnings or your relevant annual allowance (whichever is lower) into your pensions and get the full advantage of tax relief. 

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What’s an annual allowance? 

An annual allowance tells us how much we can each put into our pensions (so that’s both workplace and personal) before we could face a personal tax charge. Your annual allowance will depend on things like how much you earn or if you’ve already started taking benefits from a pension. 

We’ve listed all annual allowances below so take a look and see which one is relevant to you.

🤔 A note for low or no earners

If you earn less than £3,600 or have no earnings you can still contribute to a pension. The most you can put in your pension and get tax relief is £2,880 a year (that’s £3,600 after tax relief has been added).

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👇 Standard annual allowance  

Who this applies to? 

Most people (unless you fit a different annual allowance category below). 

What does it mean? 

With the standard annual allowance, you can put up to 100% of your annual earnings or £40,000 (whichever is less) each year into a pension.  

So if your earnings are £36,000 a year, you can add up to £36,000 into pensions that year, while still getting tax relief and avoiding a tax charge. 

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What happens if you exceed the annual allowance?

If your pension contributions go above the amount allowed by your annual allowance, you could face a personal tax charge. 

The charge effectively claws back some of the tax relief your pension plan has received and shouldn’t have. 

Any contributions over your annual allowance will be charged at your highest marginal rate of income tax. 
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How much tax relief we get depends on what rate of income tax we pay.  

Most of us in the UK are basic rate taxpayers, we earn less than £50,270, so pay 20% income tax on these earnings. This means any tax relief is also at 20%. 

Now if you don’t quite fit the above example, don’t worry. 

As we saw with the annual allowance for low or no earners, the Government gives basic rate tax relief on all pension contributions up to a certain amount regardless of whether you pay tax or not.

And if you pay more than the basic rate of tax then you’ll be able to claim further tax relief yourself. 

Using the same example:

• if you pay tax at say 40% you may be able to claim an extra 20% in tax relief. Bringing total tax relief to £40 and meaning that £100 going into your pension plan has only cost you £60.  
• if you pay tax at say 45% you may be able to claim an extra 25% in tax relief. That brings total tax relief to £45 and means £100 pension contribution only cost you £55.  

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❗ It’s important to remember though, this relief will go into your pocket rather than into your pension account. If you want to make this part of your pension savings, that’s an extra step to put it back into your pension.

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How to work out pension tax relief

How do we know what extra tax relief we can claim? That’s the million-dollar question. So here’s the million-dollar answer. 

How much tax relief you get and whether you can claim any extra depends on the income tax rate the cash you used to top up your pension was taxed at. 

So before getting into a few SIPP tax relief examples, it’s worth reminding ourselves what the UK income tax rates are. 

Basic rate taxpayer example

Let’s say you earn £15,000 a year and want to make a gross pension contribution of £10,000 that year. 

You add £8,000 to your SIPP account and you’d get basic rate tax relief (20%) added directly into your SIPP. 

So the total cost of your £10,000 pension contribution is just £8,000.
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Higher rate taxpayer example 

With earnings of £55,270 a year, you’ll pay both basic rate (20%) and higher rate (40%) income tax on your earnings. 

For a pension contribution of £10,000:

• You’ll get the basic rate tax relief added directly to your SIPP account 
• You can also claim an extra 20% tax relief back from HMRC on the contribution that was taxed at the higher rate (ie. the £5,000 taxed at 40%).  
• Thanks to tax relief, the total cost of your £10,000 pension contribution could be just £7,000.
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Additional rate taxpayer

With earnings of £154,000 a year, you’ll pay basic, higher and additional rates of income tax on your earnings. 

For your pension contribution of £10,000:

• You’ll get the basic rate tax relief added directly to your SIPP account 
• You can claim an extra 25% tax relief from HMRC on the contribution that was taxed at the additional rate (the £4,000 earnings taxed at 45%). 
• You can also claim an extra 20% tax relief from HMRC on the contribution that was taxed at the higher rate (the remaining £6,000 taxed at 40%). 
• Thanks to tax relief, the total cost of your £10,000 pension contribution could be just £5,800.
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A few notes on the charts:
These examples assume contributions will be paid by the client into a money purchase pension scheme, that the Money Purchase Annual Allowance of £4,000 has not been triggered and the client's overall tax year contribution does not exceed the Annual Allowance of £40,000.
It also assumes that the client has the standard Nil rate threshold of £12,571.
Please remember, tax treatment depends on your individual circumstances and may be subject to change in future.

The good news is that often you won’t have to do anything to get basic rate (20%) tax relief, it will happen automatically. 

There are two main ways to get tax relief: relief at source and net pay.

For a personal pension, the relief at source method is always used.  

For a workplace pension, your employer chooses which of these two methods is used.

What is relief at source? 

With a personal pension, any payments you make to your pension will be made using your after-tax pay (ie. the wages that end up in your bank account and you’ve already paid tax on). So any tax relief in this scenario will have to be claimed back from the government. 

With a SIPP, basic rate tax relief (20%) is automatically claimed and added to your SIPP account after each contribution. 

If you have a SIPP account with Freetrade we’ll claim this for you and add it to your SIPP account automatically. 

Claiming tax relief if you pay income tax above the basic rate 

While basic rate tax relief (20%) is automatic, if you pay tax at a higher rate than this you will likely be able to claim extra tax relief. 

You can do this by completing an annual self-assessment tax return and confirming any pension contributions or you can contact your local tax office. 

You’ll need to have your end of year pay statement (P60) that shows your earnings and workplace pension contributions for that year and for any personal pension contributions a contribution certificate. 

It’s important to remember though, extra tax relief will go into your pocket rather than into your pension account. 

If you want to make this part of your pension savings, that’s an extra step to put it back into your pension.

What is the net pay method?

With net pay, your pension contribution is taken from your pay before you’ve paid any income tax and before it’s paid out to you.

This way you get full tax relief at this time and don’t pay any tax on these earnings. 

If the deduction of your contributions from your pay takes your annual earnings below the income tax threshold (i.e the first £12,570 of income no one pays income tax on), then you will not get full tax relief through this method. 

This should be fixed by HMRC’s annual P800 tax calculation but you may have to make a claim via self-assessment. In these circumstances, it’s best to check with your employer.

The Freetrade Pension 

How you get your tax relief will vary depending on what type of pension it is and who is giving it to you (we’ve covered this above).  

With a Freetrade Plus plan you can open and invest in a self-invested personal pension (SIPP) which means that (like all SIPPs) basic rate tax relief is added directly into your pension account by your pension provider. 

Let's say you add £80 into your SIPP, we’ll collect the £20 (ie. the 20% tax relief) from the government directly. Making your total pension contribution £100.

It normally takes around 6-11 weeks from the day you contribute for the tax relief to appear in your account.

Carry forward rule 

If you haven’t used all of your annual allowances in the last three years, you may still be able to use some of these annual allowances.  

This is known as the carry forward rule and it allows you to add more than the annual allowance (currently £40,000) to your pension in a year while avoiding the annual allowance charge. 

To use the carry forward rule, you must: 

• have been a member of a pension scheme in each year you wish to carry forward the annual allowance
• have used up your full annual allowance this current tax year
• earn at least the amount you wish to contribute to your pension in that tax year  
• use any unused allowance from the earliest year first
• not have triggered the MPAA, you cannot use carry forward to increase the MPAA limit (currently £4,000). 
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🤔 Will I be eligible for tax relief on my contributions?

To be eligible for tax relief you must be a relevant UK individual.

You can then make a contribution of up to £3,600 each tax year on which you will be eligible for basic rate tax relief.

For contributions above £3,600, you will be eligible for tax relief on contributions of up to 100% of your relevant UK earnings. But tax relief may be clawed back if you exceed an annual allowance.

You are a relevant UK individual if you are under 75 years old and:

• have relevant UK earnings that will be subject to income tax that year, or 
• UK resident, or
• were resident in the UK at some time during the five tax years immediately before the tax year in question and were also resident in the UK when you joined the pension plan. In this case, tax relief is limited to a max contribution of £3,600 per tax year. 
• you or your spouse have, for the tax year in question, have general earnings from overseas Crown employment subject to UK tax
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What are relevant UK Earnings?

As a general rule, most income that is earned and assessable for income tax in the UK counts as relevant UK earnings.

These include:

• employment income which includes your salary, wages, bonuses and any commission 

• income from self-employment or partnership 
• income from patent rights, where you created (or jointly created) the patented invention 
• income from your job as an overseas crown employee and you pay UK tax

Please note this isn’t a complete list of relevant earnings. If you are in any doubt as to whether earnings are relevant UK earnings, then you should seek professional advice.

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🤔 How do I know what type of pension tax relief I qualify for?

For a workplace pension, your employer will choose whether to administer tax relief via relief at source or the net pay method. 

For SIPPs and other personal pensions, the relief at source method is used.

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UK pension tax relief rates 

‍Please note the above table is correct as at 30/11/2021

Scottish pension tax relief rates 

Scottish income tax bands are different from the rest of the UK. This means when it comes to pension tax relief, Scottish taxpayers have different amounts they can claim. 

Please note the above table is correct as at 30/11/2021

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🤔 How does Freetrade claim tax relief?

Freetrade will claim 'Basic Rate' tax relief from HMRC for you and deposit it in your account automatically. 

It normally takes around 6-11 weeks from the day you contribute for the tax relief to appear in your SIPP account.

🤔 Who claims tax relief above the basic rate? 

If you pay above basic rate income tax, you can claim any additional tax relief you might be owed by submitting a self-assessment tax return and telling HMRC how much you have contributed to a pension. 

🤔 What is the lifetime allowance?

The lifetime allowance is the limit on the value of benefits you can take out of your pension plans. If you take benefits over the limit you’ll generally pay a tax charge on the amount over the lifetime allowance at that time. 

For the tax year 2022-2023, the lifetime allowance is £1,073,000. 

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Important information

This should not be read as financial advice and individual investors should make their own decisions on what investments are right for them or seek independent advice.

Please remember, tax treatment depends on your individual circumstances and may be subject to change in future.

SIPPs are a pension product designed for people who want to make their own investment decisions. You can normally only access the money from age 55 (raising to 57 from 2028). Current rules can change, and tax relief depends on your personal circumstances.

When you invest, your capital is at risk. The value of your portfolio can go down as well as up and you may get back less than you invest.

Before transferring a pension you should ensure that this is the right thing for you to do and in particular check that you will not lose valuable guarantees or incur excessive transfer penalties. Pensions are usually transferred as cash so you will be out of the market for a period and therefore there is a risk you may lose out on investment gains during this period.

Freetrade does not currently offer drawdown products for our SIPP.

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