Pension Tax Relief Explained

Tax relief is the main reason pensions beat most other savings vehicles. The government adds money to your pension based on your income tax rate: 20% for basic rate, 40% for higher rate, 45% for additional rate. This guide explains how the two relief methods work, how to claim what you are owed, and how salary sacrifice adds National Insurance savings on top.

Relief at Source

Relief at source is the most common method for workplace pensions and personal pensions (including SIPPs). Under this method, your contribution is taken from your net pay (after tax), and the pension provider claims basic rate tax relief (20%) from HMRC on your behalf.

In practice, if you want to contribute £100 to your pension, you pay £80 from your take-home pay and the provider adds £20 from HMRC. This happens automatically. You do not need to do anything to receive the basic rate relief.

If you are a higher rate taxpayer (40%), you are entitled to an additional 20% relief on top of the 20% already claimed by the provider. You claim this through your self-assessment tax return. For a £100 gross contribution, you paid £80 and the provider claimed £20. You then claim another £20 through self-assessment, making your net cost £60.

Additional rate taxpayers (45%) can claim 25% extra through self-assessment (the difference between 45% and the 20% already claimed), bringing the net cost of a £100 contribution down to £55.

Net Pay Arrangement

Under a net pay arrangement, your pension contribution is deducted from your gross salary before income tax is calculated. This means you automatically receive full tax relief at your marginal rate, with no need to claim anything through self-assessment.

If you earn £40,000 and contribute 5% (£2,000) via net pay, your taxable income is reduced to £38,000. As a basic rate taxpayer, you save £400 in income tax (20% of £2,000). As a higher rate taxpayer, you save £800 (40% of £2,000). The relief is immediate and automatic.

Net pay is common in larger employer schemes and public sector pensions. The advantage is simplicity: higher rate taxpayers get their full relief without filing a self-assessment return. The disadvantage historically was that low earners (below the personal allowance) received no tax relief under net pay, while they did under relief at source. From April 2025, HMRC will make top-up payments to low earners in net pay schemes to correct this anomaly.

Check your payslip to determine which method your scheme uses. If your pension contribution is deducted before tax (reducing your taxable pay), you are on net pay. If it is deducted after tax, you are on relief at source.

Tax Relief by Income Tax Rate

The value of pension tax relief depends on your marginal income tax rate. Here is what a £1,000 gross pension contribution costs at each rate:

For higher and additional rate taxpayers, pension contributions are one of the most effective tax planning tools available. A higher rate taxpayer contributing £10,000 to their pension saves £4,000 in income tax. If they also use salary sacrifice, they save an additional £800 in National Insurance (8% of £10,000).

Scottish taxpayers have different income tax rates (19% starter, 20% basic, 21% intermediate, 42% higher, 47% top). The pension tax relief matches the Scottish rate for Scottish taxpayers. Under relief at source, the provider still claims 20% from HMRC, and Scottish higher rate taxpayers claim the difference (22% rather than 20%) through self-assessment.

How to Claim Additional Tax Relief

If you are a higher or additional rate taxpayer in a relief at source scheme, you need to claim the extra relief yourself. There are two ways to do this:

• Self-assessment tax return: enter your total gross pension contributions (including the basic rate relief already claimed by the provider) in the pension contributions section. HMRC calculates the additional relief and either reduces your tax bill or issues a refund.
• Contact HMRC directly: if you do not normally file a self-assessment return, you can write to HMRC or call them to request an adjustment to your tax code. They will spread the relief across your future pay packets by increasing your tax-free allowance.

Many higher rate taxpayers miss this step and leave money unclaimed. If you contribute £5,000 per year to a relief at source pension and you are a 40% taxpayer, you are owed £1,000 per year in additional relief. Over a decade, that is £10,000 left on the table.

You can claim back up to four tax years of unclaimed relief. If you have been a higher rate taxpayer contributing to a relief at source pension without claiming, contact HMRC to recover what you are owed.

Salary Sacrifice and National Insurance Savings

Salary sacrifice adds another layer of tax efficiency. When you sacrifice salary for pension contributions, the sacrificed amount is not subject to employee National Insurance (8% for 2024/25 on earnings between £12,570 and £50,270) or employer National Insurance (13.8% on earnings above £9,100).

For a higher rate taxpayer contributing £5,000 via salary sacrifice, the savings are:

• Income tax relief: £2,000 (40% of £5,000)
• Employee NI saving: £400 (8% of £5,000)
• Total saving: £2,400, making the net cost £2,600 for a £5,000 contribution

Without salary sacrifice, the same £5,000 contribution via relief at source costs £3,000 (after claiming the 40% relief through self-assessment). Salary sacrifice saves an extra £400 per year in this example.

Some employers pass their own NI saving (13.8% of the sacrificed amount) back to the employee as an additional pension contribution. On a £5,000 sacrifice, that is an extra £690 going into your pension. Ask your HR department whether your employer shares their NI saving. For more on how employer contributions work, see our employer pension contributions guide.

The Annual Allowance and Tapered Allowance

The standard annual allowance for 2024/25 is £60,000. This is the maximum total pension contribution (from all sources) that receives tax relief in a single tax year. Your employee contributions, employer contributions, and any personal pension contributions all count toward this limit.

For high earners, the annual allowance tapers down. If your "adjusted income" (broadly, your total income including employer pension contributions) exceeds £260,000, the allowance reduces by £1 for every £2 of income above that threshold. The minimum tapered allowance is £10,000, which applies at adjusted income of £360,000 or above.

The taper only applies if your "threshold income" (income before pension contributions) also exceeds £200,000. If your threshold income is £200,000 or below, you keep the full £60,000 allowance regardless of your adjusted income.

If you have unused annual allowance from the previous three tax years, you can carry it forward. This allows contributions well above £60,000 in a single year, which is useful after a bonus, business sale, or inheritance. See our carry forward guide for worked examples and eligibility rules. For strategies on making the most of your allowance, see our pension top-up guide.