🎓 Pensions Academy Lesson 5

Imagine that someone offered you free money with no strings attached. You’d be silly to turn it down! This is how pension tax relief works. You contribute a set amount to your pension and, to encourage you to save, the government tops up your nest egg with the same amount you would have paid in tax on your earnings.

How much free money the government will give you depends on how much you earn, how much tax you pay and how much you have contributed to your pension in the past three years. 💸

There is a cap on it, though. If you’re paying income tax in this tax year – you can usually get pension tax relief on contributions up to £40,000 (annual allowance).


How does pension tax relief work?

If you’re a basic rate UK taxpayer you’re entitled to tax relief on your pension contributions, which you can also think of as a 25% top-up. 💰 That means if you contributed £4,800 to your pension, the government will give you will give you free money in the form of a top-up of £1,200, bringing your total contribution to £6,000.

Higher rate taxpayers are eligible for 40% tax relief on their pension contributions. So, if you pay tax at this higher rate you would only have to contribute £3,600 to make an investment of £6,000 because you would receive £2,400 in tax relief.

Top rate taxpayers earn 45% pension tax relief. So taking the same total investment of £6,000, you would only have to contribute £3,300 into your pension, thanks to the government top-up of £2,700.

Here’s a simple breakdown of how much you would have to pay to contribute £100 into a pension…

With a Moneybox Personal Pension we can claim basic rate tax relief for you! 🙌 If you’re a higher or top rate taxpayer, you may have to complete an HM Revenue and Customs (HMRC) Self Assessment tax return to claim back the rest.


How does Scottish tax relief differ? 🏴󠁧󠁢󠁳󠁣󠁴󠁿

In Scotland, pension tax relief is applied in a slightly different way due to the different income tax bands. Everyone on the Scottish Basic rate is entitled to the 20% rate of tax relief (including those on the Scottish Starter rate). For Scottish taxpayers on Intermediate, Higher or Top tax rates, the additional tax relief can usually be claimed via your Self Assessment tax return, or by contacting HMRC if you don’t fill in a tax return.


What about unused pension tax relief allowances?

If you don’t use your full Annual Allowance (£40,000) from a previous year, you can carry forward your allowance to the next, ensuring you’re getting the full benefit of tax relief. 🔄 In fact, you can still make use of unused allowances from up to three previous years – just as long as you had a pension during that time. Also, you cannot contribute more than you have earned in a tax year. To carry forward any unused pension allowance, you can increase the amount you pay into your pension by talking to your pension provider. You don’t need to report this to HMRC.


What if I want to contribute more than the Annual Allowance?

You may contribute over the Annual Allowance of £40,000, however, this money won’t attract tax relief and will be taxed at the Income Tax rate that applies to you. 


What happens to my pension tax relief if I’m on a small income?

You can still pay into a personal pension on a lower income and benefit from tax relief. If you earn less than £3,600 a year, the most you can contribute into a pension is currently £2,880. This means you’d get £720 of tax relief, bringing your total pension contribution up to £3,600. 💷


What happens to my pension tax relief if I’m on a high income?

If you have an income of over £200,000 and your ‘adjusted income’ – which includes your total pension contributions from yourself, and your employer with a workplace pension, plus tax relief – is over £240,000, the Annual Allowance is reduced to as low as £4,000. This is known as Tapered Annual Allowance.


What happens to tax relief when you start to draw down your pension?

If you have a workplace or personal pension and begin to draw on it at retirement, this can reduce your annual contribution allowance down to £4,000 (for the tax year 2021-22) and is known as the Money Purchase Annual Allowance or MPAA. 

The MPAA applies based on how you access your pension pot and there can be some complicated rules around this. Find out more from Money Advice Service


Whatever your financial situation, it’s worth ensuring that your pension is benefiting from these government top-ups that you are fully entitled to. 


🎓 You’re on a roll and half way through the Pensions Academy! In Lesson 6, we tackle the million pound question – how much should I save for retirement?



 As with all investing, the value of your pension can go up and down, and you may get back less than you invest. Tax treatment on your pension contributions depends on individual circumstances and is subject to change. Payments you make into your pension won’t be accessible until the minimum pension age (currently 55, increasing to 57 in 2028).