What is pension tax relief and how does it work?

Saving enough money to fund a comfortable retirement will take most of your life, but the government helps out by providing incentives for you to put money in a pension.

One of the most important of these is pension tax relief, which means some people can save up to 45% tax on pension contributions.

You can get tax relief worth 100% of your salary (up to £60,000) a year on your pension contributions.

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But while getting tax relief is straightforward for some, others – especially higher earners – will have to claim their full entitlement.

Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “Tax relief is a major incentive to save into a pension, with the money that you would have paid to HMRC in income tax going into your pension instead.

“If you're a higher or additional rate taxpayer, it's worth checking you're getting all the pension tax relief you're entitled to because you may need to claim some of it yourself.”

How does pension tax relief work?

Pension tax relief lets you contribute to your pension without having to pay income tax on the money you are putting in.

Pension tax relief can boost your pension savings by at least 20%. Higher rate taxpayers could claim relief worth 40% , while additional rate taxpayers could get 45% relief, making it a very tax-efficient option.

Morrissey explained: “You receive tax relief at your marginal rate, which means a £100 pension contribution would cost a basic rate taxpayer as little as £80.

“For a higher rate taxpayer, it would only cost £60 and, for an additional rate taxpayer, it could be just £55. This could be lower if you contribute via salary sacrifice as you would also save on National Insurance.”

How you receive this tax relief will depend on the particular type of pension scheme you are using.

Do I need to claim pension tax relief?

Depending on the type of pension scheme you are contributing to, you may need to manually claim pension tax relief.

If you are in a “net pay” pension scheme where pension contributions are made before you are taxed, you will automatically receive any tax relief you are owed without having to claim it.

If you contribute to your pension through salary sacrifice, you don’t need to manually claim pension tax relief.

“If you’re in a salary sacrifice or net pay arrangement, you should get the right amount of tax relief. That’s because your pension contribution is deducted from your salary before income tax is calculated. That means you only pay tax on what’s left, so you’ll get full tax relief immediately,” Morrisey said.

However, you may need to take action if you are in a “relief at source” pension scheme, where contributions are made after tax is deducted.

In these schemes, the pension provider will usually claim tax relief on your behalf automatically, but will only do this at a basic rate level of 20%.

That means that if you earn more than £50,270 a year, you may only receive 20% tax relief when you are entitled to 40% if you are a higher rate taxpayer or 45% if you are an additional rate taxpayer.

Morrisey said: “If your contributions are made via ‘relief at source’, contributions are deducted from your salary after tax. The employer takes 80% of the contribution from your salary after tax and pays this to your pension provider. The pension provider then reclaims the basic rate tax relief of 20% from HMRC.

“So, if you’re entitled to tax relief at a higher rate, you need to claim the extra yourself.”

How to claim pension tax relief

If you are a high earner concerned that you are not getting the full pension tax relief you are entitled to, the first thing you should do is check what kind of pension scheme you are paying into.

If your pension contributions are being paid into a net pay or salary sacrifice scheme, you don’t need to take any action.

However, if you are paying into a “relief at source” scheme, like many Self Invested Personal Pensions (SIPPs) and other private pensions, you may need to file a tax return.

This process is “pretty straightforward,” says Rob Morgan, chief investment analyst at wealth management firm Charles Stanley.

“You can claim the tax relief on your self-assessment tax return by stating the gross amount of your total pension contributions for the tax year, including the 20% basic-rate relief already added.

“If you use the online service, HMRC calculates how much tax you have overpaid and then offsets any additional tax you owe against it.

“At the end of the process your net tax position for the year is adjusted. If you have overpaid, the balance can be refunded to your bank account as a tax rebate, or you can choose to pay less tax each month in the next financial year through a new tax code.”

If you do not usually file a self-assessment tax return, then you can claim your pension tax relief by using an online portal on the government website.

You should consider paying the rebate into your pension (rather than keeping it in your bank account) to boost your retirement fund.

Pension tax relief claims can also be backdated by up to four years, meaning you can get tax relief back from contributions you made in those previous years.

This can be done by either amending a previous tax return or contacting HMRC directly.