Pensions tax relief - why the taxman could owe you money

Pension savers are failing to claim millions of pounds of free cash from the government every year, with the taxman retaining billions of pounds in unclaimed pensions tax relief.

While there are many reasons you may need to complete one - because you’re self-employed, you make additional income or maybe case because you have to by the high income child benefit charge - anyone subject to the 40% higher rate or 45% additional rate of income tax could have unclaimed tax relief and it could mean that the tax man owes you money.

The deadline for completing a self-assessment tax return online is 31 January 2024 and you face a £100 penalty for missing this deadline and could even be charged interest in tax payments.

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New research from interactive investor suggests that around one in three higher rate taxpayers who pay into a private pension are potentially missing out on the higher rate of tax relief they are entitled to on their contributions.

The study found that 32.5% of higher rate taxpayers with private pensions are either not planning to claim the higher tax relief, or are unsure of how to go about doing so.

This could translate into substantial losses in terms of pension income. Interactive investor pointed out that for a pension saver putting £5,000 a year into their retirement savings, around £1,250 in additional tax relief could be missed out on. Over the course of 20 years, with the assumption that contributions increase by 2% each year, that’s more than £30,000 missing from the eventual pension pot.

This isn’t a new phenomenon either. A Freedom of Information request from PensionBee last year found that a total of £1.3 billion in pension tax relief went unclaimed between 2016/17 and 2020/21.

We explain who’s entitled to extra pension tax relief and how to ensure you scoop up the ‘free’ cash, rather than leaving it to the taxman.

Who qualifies for pension tax relief?

Everyone can get tax relief when they pay into a pension, even children and people who aren’t working. (Although there are limits on how much tax relief you can receive, imposed via the annual allowance).

Basic-rate taxpayers normally have the correct amount of tax relief added to their pension pots. For example, when someone earning £30,000 a year (a basic-rate taxpayer) pays into their workplace pension, they would usually benefit from a 20% top-up from the government. In other words, for every £100 that is paid into their pension, the government would add £25, bringing the total contribution to £125.

Higher-rate and additional-rate taxpayers are entitled to extra tax relief. The former receives 40% relief, while the latter can get 45%.

Whether you automatically receive the full amount of tax relief on your pension contributions, or whether you have to claim back the extra money from HMRC, depends on how your pension is paid.

If the pension provider uses a “net pay” arrangement - also known as “gross tax basis” or "salary sacrifice" then taxpayers get the full amount of tax relief straightaway.

However, other providers - including personal pensions and some workplace pensions - use the ‘relief at source’ method. This means the provider claims the first 20% of tax relief from HMRC and pays it into the pension pot.

That’s fine if you’re a basic-rate taxpayer, but for higher earners, they will be missing out on some extra money.

Many high earners are failing to claim their additional 20% or 25% tax relief, on top of the 20% relief that’s already been paid. Some pension savers may be unaware they need to claim it, or are unsure how to do so.

Tom Selby, head of retirement policy at the investment platform AJ Bell, comments: “People often mistakenly assume they will receive all their pension tax relief automatically from HMRC. However, whether you need to make a claim to receive the tax relief you are owed will depend on several factors including your income, the type of pension scheme you contribute to and how you contribute.

“Higher earning pension savers who make personal contributions to ‘relief at source’ schemes, such as Sipps, risk missing out on hundreds, if not thousands, of pounds in tax relief if they fail to notify HMRC.”

Jason Hollands, managing director at wealth firm Evelyn Partners, added that the fiscal drag means more people could end up in a higher tax bracket and could also be entitled to pensions tax relief.

“Nominal wages are rising at levels not seen in many years due to the post-pandemic surge in inflation. The most recent wage data shows UK pay (including bonuses) is rising at 6.5% pa. However, given the multi-year freeze the government has put in place for both the personal allowance (£12,570) above which income tax is paid and the threshold for paying higher rate tax (£50,270), as well as a reduction this year in the level at which the 45% additional rate kicks-in (£125,140), increasing numbers of workers are being drawn into the higher tax brackets," Hollands said. 

It is estimated a record 5.6 million people will pay higher rate tax this year - £1.8 million more than five years earlier. The Office of Budget Responsibility forecast suggests that between 2022/23 and 2028/9 the number of people paying higher rate tax will rise by 3 million.

How do I claim this extra tax relief?

If you already fill in a self-assessment tax return, you can claim the pension tax relief that way.

According to PensionBee, around three-quarters of higher-rate taxpayers eligible to claim extra tax relief on their pension contributions through self-assessment fail to do so, while almost half of eligible additional-rate taxpayers don’t claim via their tax return.

If you’re not registered for self-assessment, you can call or write to HMRC and claim your tax relief that way.

HMRC will usually adjust your tax code in order to pay the extra tax relief. If you don’t have any earnings, you may be sent a cheque instead.

By failing to claim the tax relief, higher earners are leaving hundreds of pounds of free cash on the table.

Can I claim for previous years?

If you’re panicking that you’ve never benefited from this extra tax relief on your pension contributions, the good news is that you can claim it for previous years. In fact you can claim relief dating back four years, either through amending a previous tax return or contacting HMRC directly.

PensionBee has created a Pension Tax Relief Calculator to show savers how much tax relief could be added to their pension pot. If they’re not already receiving the full amount of tax relief from their pension provider, it shows the portion they could claim back from the government.

The figures obtained in last year's FOI requests reveal that the number of high earners not claiming their extra tax relief has been falling over recent years, suggesting that more people are becoming aware of the need to claim it.

Becky O’Connor, director of public affairs at PensionBee, comments: “Tax relief is a vital incentive that encourages people to save efficiently towards their retirement and too many people - at both ends of the spectrum - continue to miss out on this crucial benefit.”