Your pension is incredibly tax-efficient. Alongside a potential tax-free cash entitlement when you come to retire, your contributions are subject to tax relief too.
This is applied to each contribution you make at the basic rate of 20%. It means that a £100 increase to your pension pot effectively costs you just £80, with the additional £20 supplied by the government.
As a high earner, you can claim extra tax relief too. This is worth a further 20% or 25% depending on your tax bracket. If you haven’t claimed this amount yet or didn’t know you could, you’re not alone.
According to reports, high earners failed to claim more than £1 billion in tax relief in the five years to 2020/21.
Keep reading for your look at how pension tax relief works, how to claim your full entitlement, and why you should.
You’ll need to understand the pension Annual Allowance and the specific threshold that applies to you
Annual Allowance
Each year you can contribute to your pension tax-efficiently up to a certain limit.
For 2023/24, your Annual Allowance stands at £60,000 (or 100% of your earnings, if lower). However, your allowance could be reduced if your income exceeds certain thresholds or you have already flexibly accessed your pension.
Tax relief is applied to contributions up to this limit.
Tapered Annual Allowance
If you are a high earner, you might be affected by the Tapered Annual Allowance. While the calculations can be complicated, the taper essentially reduces your Annual Allowance by £1 for every £2 you earn over £260,000 (including pension contributions).
The taper continues to apply until your allowance reaches £10,000.
Money Purchase Annual Allowance
Taking defined contribution pension benefits using certain “flexible” options can trigger the Money Purchase Annual Allowance (MPAA). As with the Tapered Annual Allowance, this reduces your allowance from £60,000 to just £10,000.
The MPAA, though, has no taper. You either trigger it or you don’t, and once triggered it can’t be undone.
This could have huge ramifications if you intend to withdraw funds from one of your pensions but continue paying into others. Get in touch if you have any questions about the MPAA or the allowance that applies to you.
Tax relief is automatically applied at the basic rate but you might be eligible for more
Tax relief is designed to incentivise pension saving and is automatically added at the basic rate of 20%. But as a higher earner, you could receive more.
For basic rate taxpayers, a £100 increase in their pension pot effectively costs just £80.
The relief you receive is based on the level of Income Tax you pay. Increasing the size of your pension pot by £100 could cost you just £60 as a higher-rate taxpayer. And as an additional-rate taxpayer, that figure drops to just £55, thanks to the 45% tax relief available.
But you need to actively claim this extra relief. You can do this via your self-assessment tax return. If you haven’t, you’re not the only one.
Back in February 2023, PensionsAge reported on the amount of relief claimed between 2016/17 and 2020/21.
They found that UK employees paying the additional and higher rate of Income Tax missed out on a massive £1.3 billion over five years.
This amount comprised the unclaimed tax relief of 76% of eligible higher-rate taxpayers and 46% of those on the additional rate. In monetary terms, higher-rate taxpayers failed to claim an average of £245 million each tax year during the five years to April 2021. For additional-rate taxpayers, around £18 million went unclaimed on average each year.
Making the most of your pension’s tax efficiencies gives you the best chance of reaching your retirement goals
The PensionsAge report goes on to confirm that in 2020/21 alone, higher-rate taxpayers missed out on an average of £425 each, while additional-rate taxpayers failed to claim £527 each.
Your pension’s accumulation phase will likely last decades. And while you might not be in the same tax bracket for all of those years, failing to make full use of your pension’s tax efficiencies could make a huge difference to the size of the pot you accumulate.
In turn, this could affect the lifestyle you can live in retirement, or even push your desired retirement date back.
Working with a finance professional can help you to save and invest tax-efficiently, so contact us now if you need help on the journey to your long-term goals.
Get in touch
If you have any questions about pension tax relief or any aspect of your long-term financial plans, speak to us now. Get in touch by emailing hello@fingerprintfp.co.uk or calling 03452 100 100.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance. The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
