Tax relief – the basics
Tax relief is a government top-up into your pension. The amount you get depends on the rate at which you pay tax. If you’re a basic rate taxpayer, you get 25% extra on money you pay in.
So, every £1 you pay into your pension only costs you 80p.
Tax relief on workplace pensions
If you pay into a workplace pension, the tax relief can work in one of two different ways. Your employer’s HR or pension department should tell you which one they use. They will use the same method for everyone who’s in the particular pension scheme.
However, one method penalises people who are enrolled into their workplace pension but who don’t pay tax. It effectively makes their pension more expensive than it does for someone who pays tax.
Tax relief at source
Here your employer takes tax from your wages through PAYE as normal. They then take your pension contribution from your wages and pay it to the pension provider. The pension provider then claims the tax relief from HM Revenue and Customs and adds this to your pension.
If you’ve paid £80 into your pension, your pension provider will claim £20 from HM Revenue and Customs in tax relief, if you’re a basic rate taxpayer. If you’re a higher rate taxpayer, you can claim the extra tax relief through your self assessment tax return, or – sometimes – through your PAYE tax code.
Net pay arrangement
Here your employer takes your pension contributions before they take tax from your pay. You then pay tax on your salary or earnings, minus your pension contributions.
It has the advantage of giving you tax relief at the highest rate you pay it at. This is because your employer takes and passes on your pension contributions before you pay tax.
Net pay arrangement if you don’t pay tax
Although the net pay arrangement is particularly good news for higher rate taxpayers, because they don’t have to claim the extra tax relief, it’s not good news for people who pay into a pension but who don’t pay tax.
Under the current rules, you’ll be automatically enrolled into your workplace pension if you earn more than £10,000 a year (from each job you have, if you have more than one job).
So, for example, you could earn £11,000 a year, which would mean you’d be in your workplace pension, but you wouldn’t pay tax. In this case, you wouldn’t get tax relief on your pension contributions. The amounts involved may be relatively small, but that’s not the point. If you’re a non-taxpayer and your employer uses a net pay arrangement, your pension is 20% more expensive than if they use a tax relief at source arrangement.
Tax relief if you don’t pay tax
It might seem odd that you can claim tax relief on pension contributions if you’re not a taxpayer, but the rules let you do this. Under the rules, you can pay in up to £2,880 a year and claim 20% tax relief. The tax relief increases your pension contributions to £3,600 a year. This works out at £300 a month. However, if you pay into your workplace pension and your employer uses the net pay arrangement, you will lose out because you won’t get tax relief.
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