What is pension tax relief and how does it work?

Pension tax relief is a benefit you get for investing into a UK-recognised pension scheme. Essentially, money that you would have paid to HM Revenue and Customs (HMRC) is directed into your pension savings pot – which can then potentially grow in value while it remains invested.¹

You can get pension tax relief on all pension types, including workplace pensions, personal pensions, self-invested personal pensions (SIPPs) and stakeholder pensions. How you get this tax relief may differ depending on which of the above pensions you have.

While there’s no limit to how much you can save into a pension over a year, or in total over your lifetime, there are limits on the amount of tax relief you can receive.

To understand how pension tax relief works, it’s worth first taking a quick look at Income Tax marginal rates.

• How Income Tax and marginal tax rates work

  In the UK, you’re taxed on almost all your sources of income. This can include, for example: your salary, profits from a business you own, interest from savings, dividends from shares, or rent you earn from tenants living in your property.

  But one size doesn’t fit all. You pay different tax rates for each portion of your income falling within ‘bands’ laid out by the government.

  For England, Wales, and Northern Ireland, in the 2024/25 tax year, marginal tax rates are as follows:

  Band	Taxable Income	Marginal tax rate
  Personal Allowance	Up to £12,570	0%
  Basic rate	£12,571 to £50,270	20%
  Higher rate	£50,271 to £125,140	40%
  Additional rate	over £125,140	45%

  For Scotland, in the 2024/25 tax year, marginal tax rates are as follows:

  Band	Taxable Income	Marginal tax rate
  Personal Allowance	Up to £12,570	0%
  Starter rate	£12,571 to £14,876	19%
  Scottish basic rate	£14,877 to £26,561	20%
  Intermediate rate	£26,562 to £43,662	21%
  Higher rate	£43,663 to £75,000	42%
  Advanced rate	£75,000 to £125,140	45%
  Top rate	over £125,140	48%

  To show how marginal tax rates work in practice, let’s assume you live in England and earn a salary of £100,000 per year. This is your only source of income. The first £12,570 is tax free. You’d pay 20% on your income between £12,571 and £50,270, and then 40% on the amount between £50,271 and £100,000.

  Your Personal Allowance goes down by £1 for every £2 of income above the £100,000 limit, so your Personal Allowance reduces to zero on taxable income over £125,140. This means that your effective marginal tax rate on income between £100,000 and £125,140 is 60% due to the loss of your Personal Allowance.

Although certain limits apply, which we’ll discuss, the amount of pension tax relief you can receive aligns with your marginal tax rate bands.

The above applies to England, Wales, and Northern Ireland. Scottish Income Tax rates and bands are slightly different to these, but you can still claim pension tax relief at your marginal tax rate.

• Starter rate and Scottish basic rate taxpayers will both receive 20% tax relief on pension contributions
• Intermediate rate, higher rate, advanced rate and top rate taxpayers can get pension tax relief at their marginal tax rate(s)

Learn more about pension tax relief in Scotland.

There are two ways you can receive tax relief on your pension payments. These are:

• Relief at source
• Net pay

For everyone who pays Income Tax, net pay and relief at source are exactly equal in terms of the tax relief you receive – although they work slightly differently.

With relief at source, you contribute to your pension scheme from your income after tax has been deducted. Your pension provider will then claim 20% tax relief directly from the government. This amount will be added to your savings.

For example, if you contribute £80 from your after-tax income, your provider will claim £20 from the government on your behalf. Your pension pot will grow by £100.

This 20% tax relief is at the basic rate of Income Tax. If you pay one of the higher marginal tax rates, you can claim this additional tax relief from HM Revenue and Customs (HMRC).

If you have a personal pension, the relief at source method will always be used. If you have a workplace pension, your employer may use either relief at source or net pay (see below). Whichever arrangement they use for pension tax relief, it will apply to all employees in the scheme.

• How to make a pension tax relief claim

  You’d only make a claim if your tax relief 1.) is received through relief at source and 2.) you pay more than the basic rate of 20% on part of your income.

  This is because your provider won’t automatically claim any tax relief above the 20% basic rate when you pay money into your pension.

  • For higher tax rate taxpayers, you can either contact HMRC or submit a Self Assessment tax return to claim additional relief
  • For additional rate taxpayers, you’ll need to submit a Self Assessment tax return to claim additional relief
  • For Scottish Income Tax, you can either contact HMRC or submit a Self Assessment tax return to claim additional relief

  Given the high marginal rates of these bands, this tax relief could amount to large sums of money, so it’s essential not to overlook making a claim to boost your pension savings.

With a net pay arrangement, you contribute to your pension scheme from your pay before tax is deducted. Net pay is only used by workplace pensions, and under this arrangement, your employer may offer you ‘salary sacrifice’ (also known as ‘salary exchange’).

Here, your employer will decrease your salary by the amount you’re saving into your pension. This has the benefit of lessening the National Insurance contribution you’re obligated to pay based on your salary. However, there may be disadvantages to using salary sacrifice, depending on your personal circumstances.

By contributing to your pension from your pay before Income Tax is deducted, your pension tax relief is received straight away, and nothing needs to be claimed back from HMRC.

For example, if a £50,000 salary is your only source of income and you pay £10,000 of this into your pension, this entire amount is added to your pot without any deductions. Your taxable income therefore drops to £40,000, minus the Personal Allowance.

If you pay Income Tax above the basic rate of 20% on part of your pay, you don’t have to claim this back from HMRC, as you would with relief at source.

If you earn less than £12,570 and don’t pay Income Tax, the Government will pay a top-up into your pension even if your scheme uses the net pay system.

Tax relief on your pension contributions allows you to invest more money into your pension. To illustrate how much of an effect this can have, compare saving £250 per month over 25 years without tax relief to the same contribution, but with tax relief added.

**Potential pension investment growth over 25 years, at an assumed average annualised return of 4%

Please bear in mind that because investments can fall as well rise, the future value of your pension can never be guaranteed, and the above comparison isn’t based on any product.

There are limits to how much pension savings tax relief you can get each year – but remember that these limits only apply to tax relief, and they don’t limit how much you can save into your pot.

The government will use a tax charge to reclaim any relief given on pension savings above these limits.

The limits to keep in mind include:

1. Your total income for the tax year
2. Your annual allowance
3. The tapered annual allowance, if applicable
4. The money purchase annual allowance (MPAA), if applicable

Your total income for the tax year

On your own contributions, your pension tax relief is normally limited to an amount equalling up to 100% of your income (referred to as your ‘relevant UK earnings’). This amount includes any contributions made by a third party on your behalf but doesn’t include any contributions made by your employer.

Relevant UK earnings can be your salary or wages, any bonus, interest earned on savings, dividends from shares, profits from a business you own, or rent you earn from tenants living in your property. This list isn’t exhaustive.

If you earn less than £3,600, you can receive pension tax relief on your contributions up to £2,880.

The tax relief limit of 100% of your income won’t apply if you meet or exceed your annual allowance – which will take priority.

What is the pension tax relief annual allowance?

For most people, the pension tax relief annual allowance is £60,000. This means that once all the contributions to your pension savings for the year exceed £60,000, you no longer receive tax relief. However, you can ‘carry forward’, which may mean that you can pay more and still receive tax relief.

This is because carry forward allows you to make use of any annual allowance that you might not have used during the three previous tax years, provided that you were a member of a registered pension scheme during that time.

For a defined contribution scheme, the annual allowance includes:

• Your own contributions
• Your employer’s contributions
• Any other third party who pays into your scheme, and
• Tax relief already received.

For a defined benefit scheme the annual allowance is based on the capital value of the increase in your pension benefits over the tax year. This information will be available from your provider.

The annual allowance may be reduced for those with an ‘adjusted’ income of £260,000, gradually decreasing to £10,000 for those earning £360,000 or more. This is called the tapered annual allowance.

What is the tapered annual allowance?

The tapered annual allowance gradually reduces the amount of tax relief you’re entitled to if you’re a high earner. Your annual allowance may be tapered if your total taxable income for the year, less your own pension contributions, is £200,000 or more.

If you meet certain other criteria laid out by HMRC, you could see your annual allowance reduced by £1 for every £2 your ‘adjusted’ income is above £260,000. Your adjusted income includes all your taxable income, along with the total contributions made to your pension over the tax year.

The tapered allowance is complicated to calculate, and if you think it might apply to you, we recommend that you to speak to a tax specialist or find a financial adviser.

What is the MPAA?

The money purchase annual allowance (MPAA) is a reduced annual allowance that may apply if you’ve already accessed any taxable pension income from your flexible access drawdown.

The MPAA works in the same way as the annual allowance, but the amount of money you can save into your pension that’s eligible for tax relief is much less. It’s currently capped at £10,000 per year for most people.

If you’ve withdrawn £1 or more of taxable income from your flexi-access drawdown, you might have triggered your MPAA.

Although you should have received a letter from your provider letting you know if you’ve triggered the MPAA, we recommend speaking with an adviser if you’re unsure or would like to know what your options are.

It’s also important to know how to avoid triggering it if you’re thinking of taking money from your pension.

Learn more about the MPAA

Relevant UK earnings include items like:

• Your employment income (for example pay, wages, bonus, over time or commission)
• Interest earned on savings
• Dividends from shares
• Profits from a business you own
• Any redundancy payment you might have received above the £30,000 tax exempt threshold
• Your benefits in kind from your employer: you can ask your HR department what benefits you’re receiving
• Your income from a trade, profession, or vocation either individually or in a partnership
• Rental income from a UK or EEA furnished holiday lettings businesses
• Income from a patent you hold

This list isn't exhaustive, and tax law can be difficult for a non-specialist to navigate. To ensure that you're maximising your opportunity to receive tax relief on your pension contributions, we recommend speaking with a professional.

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Footnote:

1. Investments can fall as well rise, and you may get back less than you put in. Past performance is not a guarantee of future returns.