Pensions are the most tax efficient savings schemes due to their ability to avoid or delay the payment of tax. It is still important to weigh up the benefits against their drawbacks to ensure that they are the best option for you.

There are different methods of claiming tax relief dependent upon your circumstances including;

Occupational pension schemes

Salary sacrifice

Your pension contributions are made directly on your behalf by your employer with you accepting a lower salary, which is reduced by the level of your contributions, in return.
 
The key advantage is;

Since employers also pay NICs on employees’ salaries this reduces their costs. The reduction may be passed in part or in its entirety into the employees’ pension schemes

Key disadvantage is;

Tax rebate

Pension contributions are made from your net salary (i.e. after tax). Tax is then rebated at the highest rate first. As with salary sacrifice your pension contributions are made gross (i.e. before tax). The difference is that your NICs will tend to be higher under this scheme

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Private pension schemes

Tax rebate

Any contribution made into a private pension scheme is automatically increased by the minimum tax relief rate of 20%.

As with all pension schemes you are entitled to receive tax relief at your highest marginal tax rate. Those who pay higher (40%) or additional rate tax (45%) can reclaim the tax paid from HMRC via their Self Assessment Form.

When completing the Self Assessment Form it is important to include the gross contributions made into a pension scheme.

As such, you can reclaim £20 (higher rate) or £25 (additional rate) per £80 pension contribution (i.e. £100 gross) up to the amount you have paid in higher, additional rate tax or a combination of the two

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Conditions

The maximum amount of tax you can reclaim is dependent upon your circumstances though it is a combination of a set minimum, a set maximum based on your income and a set maximum based on a general rule

Minimum tax relief is 20% (lower rate tax)

Any pension contribution made is assumed to have originated from taxed income. The UK Government therefore automatically rebates tax at the lower rate level (20%) known as relief at source. This is done whether or not tax was ever actually paid in the first place.

Therefore, each £80 paid by yourself is £100 gross since the government will have rebated £20 i.e. to account for paying 20% tax

Minimum tax rebate available to everyone

Anyone can contribute up to £2,880 into a pension scheme and receive tax relief irrespective of their income. This equates to £3,600 gross after the minimum tax relief is received

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Maximum tax relief according to income

Anyone can contribute up to 100% of their salary per annum and potentially receive tax relief on the full amount. Due to the minimum tax relief and the fact that most people are entitled to receive a personal allowance they can have a pension contribution of 100% of their salary and still have up to 20% income left over.

See the non tax payer example below on how this works in principle

Maximum tax relief according to annual allowance

The UK Government has set a maximum level of tax relief claimable per year which is known as the annual allowance. The rate for tax year 2015/2016 is £40,000. In addition, any allowance not used in the previous 3 years can be carried forward with the caveat that you were a UK pension scheme member, which includes qualified overseas pension schemes such as QROPS, in those years.

The annual allowance rate for tax years 2012/2013 and 2013/2014 was £50,000 whilst for tax year 2014/2015 it was £40,000.

This creates an upper limit for claimable annual allowance of £180,000 in tax year 2015/2016 (i.e. £40,000 x 2 + £50,000 x 2)

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Applying the conditions

It is your responsibility to follow the rules concerning claiming tax relief. If you receive a larger tax rebate than you are entitled to then HMRC may demand that you pay penalties on top of refunding the excess tax relief claimed.

The maximum UK pension contribution you can make is;
 
Pensions: Maximum pension contributions. Income < £3,600pa then £3,600 gross or £2,880 net; income < annual allowance then annual allowance gross (entitled to 20% tax rebate on personal allowance contributions; otherwise annual allowance gross. Tax relief at highest marginal rate: 45%, 40% then 20%. Min tax relief is 20% up to maximum limit

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Examples

Annual income is £0. You contribute £2,000 into a pension. This is automatically increased to £2,500 by the government. No further action is required
Annual income is £10,000. Your personal allowance is £10,600. Since your income is below your personal allowance your gross and net income are both £10,000. You are still entitled to contribute the full gross amount into a pension. As a result of the minimum tax relief received you make a net contribution of £8,000 which is automatically increased to £10,000 by the UK Government via relief at source. No further action is required
Annual income is £30,000. Your personal allowance is £10,600. You pay £4,000 into a pension. This is automatically increased to £5,000 by the government. No further action is required
Annual income is £170,000. Your personal allowance is £0 so you are liable for tax on the full amount. You have contributed £20,000 gross per annum in the previous 3 tax years to your pension. This year, however, you contribute £40,000 into a private pension. This is automatically increased to £50,000 by the government via the minimum tax relief.
 
As per UK tax rules your annual income is taxable at 20% up to £42,385, then 40% up to £150,000, and 45% from £150,001 onwards. You are entitled to your unused annual allowance from the previous 3 tax years (£30,000 each year) in addition to this years allowance so you can receive tax relief up to £130,000 (40,000 + 3 x £30,000).
 
From the £50,000 in the pension a further tax rebate of 25% can be claimed on £20,000 (£170,000-£150,000) and 20% on £30,000 (the rest of the gross pension contribution) which totals £11,000 (i.e. 20,000 x 0.25 + 30,000 x 0.2). This is reclaimed via your Self Assessment in the form of a tax rebate and is not added to your pension contribution. As such your net contribution is £29,000 (40,000-11,000)
Annual income is £170,000. Your personal allowance is £0 so you are liable for tax on the full amount. You have contributed the full annual allowance to your pension in the previous 3 tax years. This year you contribute £40,000 into a private pension. This is automatically increased to £50,000 by the government via the minimum tax relief.
 
Your annual allowance is £40,000. You are only entitled to tax relief on £40,000 rather than the £50,000, which is now in your pension. Of that, based on your income, you are entitled to reclaim a further tax rebate of 25% on £20,000 (i.e. £5,000) and 20% on the remaining £20,00 (i.e. £4,000) resulting in a rebate of £9,000.
 
However, you have already received basic rate tax relief on the full £40,000 i.e. £10,000 when you should have only claimed £8,000 tax relief on £32,000 (40,000 x 80%). The additional tax relief of £2,000 has to be refunded. Your rebate as a result is only £7,000 (9,000 – 2,000) so your net pension contribution is £33,000 rather than £29,000.
 
The best option would be to contribute £32,000 to your pension which is the maximum allowed under current rules. If you were adamant on contributing the full £40,000 then you could notify your pension provider to ensure they only request tax relief on £32,000. In both cases the additional tax relief would be reclaimed via your self assessment in the same way as above.
When you contribute in excess of your salary it is important to notify either your pension provider, so that they don’t claim tax relief on the excess, or HMRC via your Self Assessment Tax Form

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Consequences of contributing in excess of your annual income or annual allowance

If you accidentally contribute in excess of your annual limits you should notify HMRC to repay the difference. Failure to do so may result in HMRC demanding that you repay the excess tax relief along with potential fines.

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UK pension tax relief written by Liberty Wealth average rating 4.7/5 - 6 user ratings