Contents
Types of Pension Schemes in the UK
There are three major types of pension schemes in the UK, which differ in contribution requirements and eligibility criteria, specifically state and workplace pensions, both of which are usually through a salary sacrifice scheme. Personal pension contribution, on the other hand, is available for everyone, even for non taxpayers.
Most of the time, taxpayers have more than one avenue for retirement savings, depending on how they plan to boost the value of their saving. They may have a state pension and at the same time set up personal or workplace pensions. Here is the difference between each type of pension scheme:
State Pension Scheme
State pension is a government-initiated pension savings method which taxpayers can withdraw at the current retirement age. The retirement earnings a taxpayer can withdraw weekly or in a lump sum pension income depends on the national insurance contributions they made and their qualifying national insurance years, usually at a salary sacrifice arrangement.
Not everyone receives the same amount—some get a portion; others get full payments. For the current tax year, the UK government sets the retirement age at 66 for men and women, which they can withdraw in some amount or full payment before or after they retire if they pay into a pension contribution of 10 qualifying years or more.
Taxpayers can claim a net pay lump sum or regular salary-like income, preferably whichever method they can get tax relief. The government is still considering whether to carry forward the age for receiving state pensions savings.
On 6 April 2016, the government announced the new state pensions system to take effect, which will apply to people who have reached the government-set retirement age on or after this day. The old state pension continues to apply to people who have reached retirement on or before 6 April 2016.
The new state pension makes it easier for people to access information on their pension saving earnings earlier and plan their source of income and tax matters for the rest of their lifetime. The amount of tax relief you can get for state pensions income depends on how much you withdraw in a tax year.
Read our comprehensive guide on tax on pension earnings for further information about state pensions investment, the tax you pay on it, ways to get tax relief, and every other question answered by details.
Workplace Pension Scheme
Every employer is obliged to automatically enroll their employees in a workplace pension scheme once the latter meets the eligibility criteria, with the employer working with a pension provider. Both the employer and the employee pay into a pension at a certain percentage whilst the government may offer certain kinds of tax relief.
Earners with a monthly payslip that amounts to at least £10,000 each year must be set up with a workplace pension scheme by their employer, except for some circumstances. For example, you have a certificate from HM Revenue Customs for your lifetime allowance protection or that you are a limited liability partner. Whether or not someone is eligible for auto-enrolment features, their employer should not deny them a workplace pension scheme if they want to join.
There are two types of workplace pensions:
- Defined benefit pensions. This workplace pension is also known as final salary or salary-related pension. The retirement income will depend on your salary payroll and how many years you worked for an employer. You can get tax relief when you withdraw some of the savings’ income in a net pay lump amount if it is within the annual allowance threshold.
- Defined contribution pensions. Also called money purchase scheme, the employer decides which specific kind under the workplace pension scheme the earners will be put in. Both the employer and employee pay into a pension, and the pension provider will diversify and boost the investment, for example in stocks and shares. This workplace pension scheme allows you to decide where your money goes, not just the pension provider.
Personal Pension Scheme
- Stakeholder pension. This is a more flexible and cheaper way of making a pension contribution. However, the stakeholder must meet the government’s specific standards, for example limits on charges.
- Self-invested personal pension (SIPP). Putting your savings in this pension contribution method allows you to control your investments and boost more of your net pay earnings over time.
Income Tax You Pay on Pension Earnings
Before delving into how relief on pension contributions work, know the annual allowance and the income tax you pay first. Tax relief on pension contribution depends on both the type of pension scheme and the tax band your income belongs to.
The income tax rates in Scotland have a slight difference from that of Northern Ireland, England, and Wales. For the 2023/24 tax year, you pay income tax if you live in the latter parts of UK as follows:
| Tax Band | Taxable Income | Rate of Income Tax |
|---|---|---|
|
Taxpayer Annual Allowance |
Capped at £12,570 |
0% |
|
Basic Rate Taxpayer |
Between £12,571 and £50,270 |
20% |
|
Higher Rate Taxpayer |
Between £50,271 and £125,140 |
40% |
|
Additional Rate Taxpayer |
More than £125,140 |
45% |
| Tax Band | Taxable Income | Rate of Income Tax |
|---|---|---|
|
Taxpayer Yearly Limits |
Capped at £12,570 |
0% |
|
Starter Rate Taxpayer |
Between £12,571 and £14,732 |
19% |
|
Basic Rate Taxpayer |
Between £14,733 and £25,688 |
20% |
|
Intermediate Rate Taxpayer |
Between £25,689 and £43,662 |
21% |
|
Higher Rate Taxpayer |
Between £43,663 and £125,140 |
42% |
|
Top Rate Taxpayer |
More than £125,140 |
47% |
In Scotland, the yearly threshold for pensions saving or taxable salary earnings over £100,000 is at one pound for every two pound. The higher or additional rate taxpayer pays 42% instead. You pay income tax to HM Revenue Customs either through PAYE or self assessment tax return.
Whilst getting your retirement income is tax efficient through pension pots, as you receive tax relief, like every source of income, pension earnings are considered an ordinary income, which means you pay tax once it exceeds the annual allowance threshold. When you claim a larger amount than you need in a year, your taxable income may be pushed to higher or additional rate in effect, which means tax charge will also rise.
How Does Relief on Pension Contributions Work?
Contributing to a pension is the most tax-efficient way to invest for retirement. You can claim back up to 100 per cent of the tax you pay for your annual income, especially if you put the amount into a private pension, whether it is on a relief at source or net pay arrangement. In England, Wales, or Northern Ireland, higher or additional rate taxpayers benefit from:
- 20% tax relief for the income paid with 40% income tax (higher rate)
- 25% tax relief for the income paid with 45% income tax (additional rate)
For example, your yearly salary or self-employed income reached £60,000 in a tax year. That means you pay tax at a higher income tax rate (40 per cent) on the portion of your earnings, which is £10,000. Once you invest £15,000 into a pension pot, you can automatically get a relief at source arrangement, so tax relief applies to the full amount of £15,000.
As you are a higher rate tax payer, you can receive tax relief of 20 per cent on your £10,000 pension contribution. However, you cannot claim additional tax relief for the remaining £5,000 balance of your contribution to any type of pension scheme.
In Scotland, higher or additional rate taxpayers can claim additional tax relief as follows:
- 1% tax relief for the income paid with 21% income tax
- 21% tax relief for the income paid with 41% income tax
- 26% tax relief for the income paid with 46% income tax
You can receive tax relief automatically through relief at source arrangement or claim tax relief yourself. For more information on how you can claim back your tax relief for your pension contribution, reach your pension provider, employer, and other key people involved.
If you are a higher rate tax payer, reach HM Revenue’s phone line or send a letter for a claim request. It is also a wise decision to have a tax adviser on your behalf as they can give you comprehensive details on this matter and ensure you receive tax relief to the maximum.
Who Can Claim Tax Relief on Pension Contributions?
Someone with personal or workplace pensions can claim tax relief automatically, if in the following situation:
- Through salary sacrifice arrangement, the employer deducts workplace pensions amount from their salary before deducting the rate of income tax in their tax return;
- Whether or not someone pays for their pension and their pension provider claims the tax relief from HMRC at the basic 20 per cent rate and add the relief to the pension pot, also called as relief at source arrangement
If you are a basic rate tax payer (you pay income tax at 19 per cent), you will still claim back tax relief at the same 20 per cent without having to pay the difference.
However, if your pension provider or employer did not set you up for automatic relief or it is on a net pay arrangement, you will claim tax relief on the following grounds:
- Via self assessment tax return;
- If you do not file self assessment tax return, call or write to HMRC;
- Your pension scheme has been registered on the HMRC website.
It is more convenient to set up your pension scheme on a relief at source arrangement instead of net pay arrangement so the tax relief will be immediately credited to your pensions amount. Your pension provider claims on your behalf. Either your pension provider or employer sets up relief at source.
Personal pensions’ relief at source is arranged by the pension provider. The provider claims the tax relief time comes for making a claim. On the other hand, someone employed will have their relief at source arranged by their employer if they are automatically enrolled. Their salary payslip and tax return will reflect the relief at source scheme.
Do Pension Contributions Reduce Your Taxable Income?
Through tax planning, making pension contributions is one of the most tax-efficient means of investing your wages or other forms of income, as less tax obligations mean a great boost of money you can keep for yourself. As long as your pension scheme is registered in HMRC website, you can claim the tax you pay up to 100 per cent of your salary payslip tax deduction.
Tax relief for pension contributions is most helpful for higher or additional rate tax payer as they can claim the tax amount they paid as reflected on their payslip, or even if they are on a net pay arrangement. If relief at source, their provider claims on their behalf.
How to Claim Pension Tax Relief?
When you make a tax relief claim for an amount over £10,000, you need to send a letter to HMRC, including proof such as payslip, when the tax amount is deducted, and more. You are also still eligible for tax relief even if you do not pay income tax. However, you are not entitled to relief if you contribute to a personal term insurance policy. Take, for example, life insurance policies.
To claim the full amount of your tax relief, work with expert tax advisors. Legend Financial is here to help you take advantage of your yearly tax-exempt limits, provide advice on which pension scheme is most tax-efficient according to your unique circumstance, and make the most accurate relief claims on your behalf.
Claiming Higher Rate Tax Relief on Pension Contributions
Tax help on pension contributions for high paid workers works somewhat better, be that as it may. With higher and different rates, citizens get to appreciate significantly more assessment relief when they contribute.
In the UK, a higher rate pension tax relief is 40% on profit above £50,270. That implies your pension contributions can get 40% back as assessment relief. You’ll get the first 20% added to your pot consequently. The excess 20% you’ll have to effectively guarantee back from HMRC through a self-appraisal assessment form or by calling or writing in. How about we check out specific models. If you’re a basic rate citizen, you’ll have to add £80 if your own cash to get £100 into your pension. That is £20 back from the public authority, a 25% reward.
With the higher rate tax help on pension contributions, you’ll just have to add £60 of your own cash to get the equivalent £100 in your pot. That works out as a 66% assessment reward. You’ll appreciate 45% assessment help for extra rate citizens on every relief. £55 of your cash implies £100 in your pension – an expense reward of more than 80%. Not terrible.
How Do Pension Contributions Interact with Tax Credits and Universal Credit?
Assuming you get a method tried advantages like all-inclusive credit or tax breaks, your pension contributions diminish how much pay that is considered in evaluating your honor. This could mean a higher benefit. For example, all-inclusive credit’s ‘tighten pace’ of 55p in the pound implies that a £100 pension relief throughout a year could result in a £55 expansion in your UC grant contingent upon your degree of grant and conditions.
You should check the position cautiously for anything beneficial you are asserting. The means you really want to take to ensure the specialists are familiar with your pension relief sums may rely upon whether you are in a net relief plan or relief at source.
For example, tax breaks depend on gross pay – before tax and National Insurance contributions are deducted. If you make contributions under a net relief course of action, the available pay figure on your P60 will, as of now, mirror your pension contributions. You won’t have to make any further changes to pension contributions.
However, the gross pay figure from your P60 won’t mirror any relief at source pension contributions, and you will, in this manner, need to deduct your pension relief sum from your pay figure when you report it to HMRC. The add up to remove is how much pension relief earned up by 100/80 (this implies you duplicate the sum you paid by 100 and afterward partition the sum by 80) – to mirror the 20% top-up that will be guaranteed from HMRC by your pension plot.
Do not miss out on tax relief for your pension contribution. Pensions are made for this purpose—for you to keep more money for yourself during retirement instead of it being paid to hefty tax duties. Legend Financial is here to provide you with comprehensive tax support all the way, having solved hundreds of claim cases for both employed and self-employed clients. Reach us today!
References
Contributing to your pension. (n.d.). Retrieved from AJ Bell: https://www.ajbell.co.uk/pensions-and-retirement/pensions-explained/contributing-to-your-pension
How pension tax relief works. (n.d.). Retrieved from Fidelity International: https://www.fidelity.co.uk/pension/tax-relief/
Tax benefits. (n.d.). Retrieved from Legal and General: https://www.legalandgeneral.com/retirement/pensions/pension-tax-relief-benefits/
Tax on your private pension contributions. (n.d.). Retrieved from GOV.UK: https://www.gov.uk/tax-on-your-private-pension/pension-tax-relief#:~:text=You%20can%20get%20tax%20relief,100%25%20of%20your%20annual%20earnings.&text=employer%20takes%20workplace%20pension%20contributions,(‘relief%20at%20source’)
Tax on your Private Pension Contributions. (n.d.). Retrieved from East Cambridgeshire District Council: https://www.eastcambs.gov.uk/content/tax-your-private-pension-contributions
Tax relief on pension contributions. (n.d.). Retrieved from Imperial College London: https://www.imperial.ac.uk/human-resources/pay-and-pensions/pensions/tax-relief-on-pension-contributions/
