According to a recent report in the Daily Telegraph , hundreds of thousands of higher earners have failed to claim more than £1bn in pension tax breaks over the past five years.
While pension savers receive tax relief on the money they put into their retirement pots at the same rate as the pay income tax, those who pay the higher 40% and 45% rates must apply for extra relief by filling out an annual tax return. However, analysis shows that three in four higher-rate taxpayers failed to do this between 2016 and 2021.
What is pension tax relief?
Pension saving is an excellent way to reduce taxes, as all the money you pay into a pension qualifies for tax relief. Pension contributions are free of income tax, and the government pays tax relief on pension contributions to encourage saving for retirement. This means that your pension provider can claim tax back from HMRC and add that amount to each contribution you make, providing an instant boost to your savings and helping the fund to grow faster than other kinds of investment.
How much tax relief can you get?
If you're a basic-rate taxpayer, you'll get 20% tax relief, which means every pound you pay becomes £1.25. Receiving 20% tax relief is the equivalent of having a 25% boost to every contribution you make into your pension. If you're a higher-rate taxpayer, you'll get 40% tax relief, and additional-rate taxpayers get 45% tax relief. However, this additional tax relief isn't delivered automatically.
Claiming your extra tax relief
The basic 20% tax relief will be added to each contribution, but if you're a higher or additional rate taxpayer, you'll have to claim back your extra tax relief via your tax return. If you earn over £50,270, you can claim an extra 25% back on your pension contributions. It's important to know how much you can pay into a pension and still receive tax relief. There is a cap on how much you can contribute to a pension in a single year, and also a limit to the total size of all your pension pots over a lifetime. If you exceed these limits, you'll have to pay additional tax charges.
Reducing taxable income with pension contributions
Another way to reduce your taxable income with pension contributions is by using a salary sacrifice scheme. In this kind of scheme, your employer agrees to make additional pension contributions on your behalf in exchange for reducing your salary by a certain amount. This saves on National Insurance contributions, so you can potentially get a higher pension contribution than you could have afforded yourself from your salary. It can also have the effect of reducing your salary to a lower tax band. If you're earning over £50,000 a year, you will be considered a higher rate income tax payer, though you can claim back higher-rate tax relief on pension contributions above that threshold.
Tax relief on pension contributions is a real help when it comes to saving for retirement. It provides an instant boost to your savings and helps the fund to grow faster than other kinds of investment. At the same time, it's crucial to understand your allowances and limits so that you don't contribute too much and end up paying tax charges. If you're a higher-rate taxpayer, don't forget to claim back your extra tax relief on pension contributions. Whatever your situation, talk to our RLFS financial advisers to make sure you're benefitting as much as possible from pension tax relief.
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