Intro to UK Pensions and Tax Relief

UK residents should get to know the government’s pension scheme to take full advantage of the tax benefits it brings.

Deel Team
Written by Deel Team
April 26, 2022
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by Yonatan Muyal, UK Accountant and Payroll Manager at Deel

For some, the word “pension” is synonymous with retirement and a career coming to an end, but for others, it’s a tool to save for your retirement. In the UK, the government provides a financial incentive to encourage saving.

How does tax relief work?

The UK government tops up the savings you put into your pension in the form of pension tax relief. It’s their way of rewarding taxpayers for taking steps towards saving for retirement. How much pension tax relief you get depends on your highest tax bracket. The more you earn, the higher your tax rate—so your tax relief increases too.

The following table illustrates this:

 

Basic Rate Taxpayer

Higher Rate Taxpayer

Additional Rate Taxpayer

Individual’s contribution

£80

£60

£55

Government’s contribution

£20

£40

£45

Total Contribution

£100

£100

£100

Basic rate taxpayers (individuals earning less than £50,270 per year) receive 20% pension tax relief. That means for every £100 added to your pension pot, £80 is paid by yourself, and the remaining £20 is added by the government. The £20 is automatically claimed on your behalf by your pension administrator.

Higher rate taxpayers (individuals earning between £50,270 and £150,000) receive an extra 20% relief for a combined 40% pension tax relief rate. That means to increase your pension savings by £100, you just need to contribute £60, and the government will provide the remaining £40.

Additional rate taxpayers (individuals earning above £150,000) receive an extra 25% tax relief for a combined 45% pension tax relief rate.

For occupational pensions using a “relief at source” scheme, tax relief is not automatic for higher earners. If you fall under the higher rate or additional rate tax bracket, you claim the additional 20 or 25% tax relief on a self-assessment tax return or contact HM Revenue & Customs directly.

Annual allowance

The annual allowance (AA) is the maximum amount you can contribute to a pension in a year for tax relief. Pension contributions made by the individual, their employer, or a third party all count. If you go over your AA, the excess amount gets taxed at your highest tax rate. If that happens, you can pay the tax charge directly or select a “scheme pays” option, where the pension fund takes money out of your pension to pay it for you.

The UK government introduced the AA in 2006 with an initial limit of £215,000. It’s steadily decreased to the current standard level of £40,000.

For 2021-22, the threshold income and adjusted income are set at £200,000 and £240,000 respectively, with a minimum tapered AA reduced to £4,000 for those with adjusted income over £312,000.

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Lifetime allowance

The lifetime allowance (LTA) is the overall limit that can be amassed in an individual’s pension savings without incurring a tax charge. The current standard allowance is £1,073,000, which is frozen until April 2026.

The capital value of a fund is calculated as follows

Capital value = (annual pension amount x 20) + lump sum

The LTA is calculated based on the pension’s capital value. If the capital value exceeds the LTA, a lifetime allowance tax charge will apply.

  • 25% of the capital value where the excess is being taken as a pension income, plus your marginal income tax rate when income is drawn; or
  • 55% of the excess if it is to be taken as a lump sum. Any pension lump sum above 25% of the LTA value is also taxed at 55%.

What should I do when I file this year?

Before the tax year ends in April 2023, review your pension contributions to see whether it would be advantageous to increase your pension contributions or even consider paying a lump sum into your pension before the end of the tax year.

Arrangements around pensions can be complex and, in some cases, lead to excess tax charges. Constant changes to the annual allowance, coupled with lifetime allowance charges are good reasons why those looking to save for the future would be wise to seek professional advice  from an accountant or tax planner.

Do employers contribute to a pension too?

Under the Pensions Act 2008, every UK employer is required to offer and contribute to a pension scheme. That means UK employees benefit from matching tax-free contributions to their pension, further growing their pension pot. 

Companies using Deel to hire employees in the UK have pensions schemes set up for them under our EOR service. We’ve partnered with NEST to manage this mandatory workplace pension scheme.

Not yet using Deel? Deel lets you hire independent contractors and employees in over 150 countries, stay compliant with local labor laws, and handle global payments. To learn more about our compliance and payroll solution, chat with an international hiring specialist today or try our free hiring cost calculator.

Disclaimer: This article is provided for informational purposes and should not be treated as financial advice. Check with an accountant for support and consult official sources for the latest information.

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