What is tax relief?
Tax relief is a government scheme designed to help you plan and save for your retirement.
Depending on the type of pension, tax relief can be a reimbursement of the tax already paid on a pension contribution or it can be the ability to put away for your pension straight out of your wage, before paying any tax.
Tax relief is one of the key benefits of investing in a private Pension such as our Self-Invested Personal Pension (SIPP) but often it can be confusing. I’ve answered some of the key questions we get asked about tax relief and how it works…
How does tax relief work?
Tax relief on employer pensions
For most employer pensions, you will receive a form of tax relief known as tax relief ‘at source’.
The government allows your Pension contributions into an employee Pension to be made before any tax is deducted from your pay packet. Given employer Pension contributions are a percentage of your wage, the amount you contribute is larger than it would be had you already been taxed!
Tax relief on private pensions
Tax relief on a private Pension acts as a top-up to your Pension pot – it essentially reimburses the tax you have already paid on the contributions you make. How much you’ll receive depends on your tax bracket.
Basic-rate tax payers, and those who don’t pay tax, will earn 20% tax relief. Higher-rate tax payers earn 40%.
So, for example, a basic-rate tax payer will have been taxed £20 on every £100 they earn, leaving them with £80 after tax. If they then contribute this £80 to a pension, they will receive £20 tax relief, giving them back the tax they paid on that £100.
Higher-rate tax payers paid 40% tax on their £100, and so receive £40 back for every £60 they contribute to a pension.
For additional-rate income tax payers, who earn more than £150,000 a year, tax relief is 45%, so they get £88.81 for every £100 they pay into their Pension. There are other rules that apply for additional-rate payers depending on specific circumstances.
How can I claim tax relief?
For tax relief at source into an employee pension, you don’t need to do anything to claim tax relief regardless of your tax rate.
Similarly, if you’re contributing to a private Pension such as a Self-Invested Personal Pension (SIPP) and you’re a basic-rate tax payer, you shouldn’t need to do anything to receive your top-up of tax relief – it gets automatically added to your Pension pot.
However, if you’re a higher or additional-rate tax payer, you may have to fill out a tax return to receive tax relief on a private Pension.
What about claiming back tax relief on Pension contributions from previous years?
If you’re a higher or additional rate tax payer and you didn’t claim tax relief on past contributions, there may be something you can do.
The government allows you to claim back tax relief you missed within four years of the end of the tax year you are claiming for. This can be done through a tax return.
Is there a limit to how much I can claim tax relief on?
There is an annual limit on the amount of money that you can pay into a pension and earn tax relief on.
The limit is currently 100% of your earnings up to a maximum of £40,000 a year, and a lifetime limit of £1 million.
If you earn £3,600 or less, the limit is £2,880 (excluding the tax relief you receive).
You will have to pay income tax on any payments into your pension that are over these limits.
Tax relief can make a huge difference to your retirement income and it’s important to be aware of what relief you can claim, so you make the most of what’s available to you for free!
If you’re considering investing into a private Pension and you want to know how and what’s best for you, you can try out our online journey and we’ll give you a personalised recommendation to suit your goals.