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Pension tax relief

Pension tax relief

The government offers tax relief on pension contributions to encourage people to save for their retirement. This tax relief is given at the tax payers marginal rate of income tax; so for basic rate tax payers there is 20% tax relief available, for higher rate tax payers there is 40% tax relief available and for additional rate tax payers there is relief of 45% available. For contributions to a personal pension this relief comes in the form of the basic rate tax relief being added to the contribution and any higher or additional tax relief being claimed back via a self-assessment tax return.

For example:

For a higher rate tax payer, with the relevant allowances available, a £1,000 gross pension contribution would only cost them £600.

In practice, the higher rate tax payer could contribute £800 to a personal pension; this would topped up to £1,000 through basic rate tax relief. Then, as a higher rate tax payer, this individual could claim a further £200 on their tax return, thus meaning for this individual their £1,000 pension contribution would have only cost them £600.

Contributed:  £800

Amount added to Pension inc government top up: £1,000

Tax Claimed Back via self-assessment: £200

Total Cost: £600

Pension contribution limits

There is technically no limit on pension contributions that an individual can make; however there are limits to the amount of contribution on which tax relief is available – thus making contributions over the below limits inefficient.

The main two limits on tax relievable contributions are an individual’s relevant earnings and the pension annual allowance.

The general rule is that UK tax payers can get tax relief on pension contributions each year on the lower of 100% of their earnings (only on earnings classed as relevant) or £40,000 which is the pension annual allowance. One exception to this rule is that individuals up to 75 that have no income can get tax relief on pension contributions up to the value of £3,600.

An individual’s contributions may be restricted further than the above general rules for two reasons. Firstly, they may be subject to annual allowance tapering. Annual allowance tapering impacts high earners, whereby an individual’s annual allowance will be reduced on a tapered basis if they earn over a certain amount. Secondly, they may be subject to the Money Purchase Annual Allowance (MPAA). The MPAA reduces an individual’s annual allowance to £4,000 and come’s into effect if the individual has flexibly accessed their pension. Both annual allowance tapering and the Money Purchase Annual Allowance have a complex set of rules so if you have any questions please contact your adviser.

Carry forward

One way individuals may be able to make tax relievable pension contributions above the pension annual allowance is through carry forward.

Carry forward allows an individual to make use of any annual allowance that may not have been used from the past 3 tax years. In order to make use of carry forward an individual must first have used their full current year annual allowance, at which point they can then look back at previous years for any unused allowance, starting with 3 years ago. If there is unused allowance available the individual can then use it in the current year in order to make a tax relievable pension contribution above the current year annual allowance.

Relevant earnings limits still apply to carry forward contributions meaning that an individual can still only receive tax relief on contributions up to the amount they earn, even if there is carry forward allowance available beyond this level.

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