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You can claim tax relief for your private pension contributions worth up to 100% of your annual earnings, subject to the overriding limits listed below. Tax relief is paid on pension contributions at the highest rate of Income Tax paid.
This means that:
- A basic rate taxpayer gets 20% pension tax relief.
- A higher rate taxpayer can claim 40% pension tax relief.
- An additional rate taxpayer can claim 45% pension tax relief.
The first 20% of tax relief is usually delivered automatically as your pension provider will claim it as tax relief and add it to your pension pot. This is known as ‘relief at source’.
If you are a higher rate or additional rate taxpayer, you can then claim back any further reliefs on your self-assessment tax return. For example, every £1 invested by a higher rate taxpayer in pension contributions is effectively worth about £1.66 and every £1 invested by an additional rate taxpayer is worth around £1.80.
The Income Tax rates are different in Scotland and this means that the tax relief on pension contributions is calculated slightly differently.
- A starter rate taxpayer (in Scotland) pays 19% Income Tax but receives 20% pension tax relief.
- A basic rate taxpayer (in Scotland) pays 20% Income Tax and gets 20% pension tax relief.
- An intermediate rate taxpayer (in Scotland) pays 21% Income Tax and can claim 21% pension tax relief.
- A higher rate taxpayer (in Scotland) pays 41% Income Tax and can claim 41% pension tax relief.
- An additional rate taxpayer (in Scotland) pays 46% income tax and can claim 46% pension tax relief.
The annual allowance for tax relief on pensions has been fixed at £40,000 since 6 April 2014. This means that the most you can pay into pensions in a single tax year is £40,000.
Any contributions over this limit will not attract Income Tax relief and you may also have to pay an annual allowance charge. HMRC does not tax anyone for going over their annual allowance in a tax year if they retired and took all their pension pots because of serious ill health or if they died.
The annual allowance is further reduced for high earners. Since 6 April 2020, the tapered annual allowance increased from £150,000 to £240,000. This means that anyone with income below £240,000 is no longer affected by the tapered annual allowance rules. Those earning over £240,000 will begin to see their £40,000 annual allowance tapered. For every complete £2 income exceeds £240,000 the annual allowance is reduced by £1. The annual allowance can also be lower if the taxpayer flexibly accessed their pension pot.
There is also a lifetime limit for tax relief on pension contributions that needs to be considered. The limit is currently £1,073,100 (2020-21). The lifetime allowance is the maximum amount of pension benefit that can be drawn from pension schemes and that can benefit from tax relief.
The rate of tax you pay on pension savings above your lifetime allowance depends on how the money is paid to you - the rate is:
- 55% if you get it as a lump sum; or
- 25% if you get it any other way, for example, pension payments or cash withdrawals.
There is a three-year carry forward rule that allows you to carry forward previous years unclaimed allowances for up to three years. You do not need to report this to HMRC.
If you have unused annual allowances for more than one year, you need to use the allowance in order of earliest to most recent. Any remaining balances can be used in future tax years, subject to the usual time limits.
The calculation of the exact amount of unused annual allowance that can be carried forward can be complicated especially if you are subject to the tapered annual allowance.