Learn how tax relief for a member operates including eligibility, methods of claiming tax relief and case studies.
- Tax relief for a member is only available if the member is a relevant UK individual.
There are three ways in which tax relief can be received – net pay method, relief at source and claiming from HMRC.
The overall tax relief will be the same using net pay and relief at source but the calculation works differently.
Who may contribute?
Pension contributions can be paid by:
- an individual who is a member of a pension scheme
- that individual's employer
- a third party on behalf of that individual.
This article relates to how tax relief operates on pension contributions made by individuals or on their behalf by a third party. The tax treatment of employer contributions is covered in our Tax relief on employer contributions
Tax relief is given on contributions 'paid' during a tax year. They must be a monetary amount and paid for example, by cash, cheque, direct debit etc.
There’s 'no limit' to the amount of contributions that can be paid. There are, however, limits to the amount of tax relief that can be obtained on those contributions.
This article deals with UK tax relief. Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. This could mean the amount of income tax relief which can be claimed on pension contributions by Scottish and UK tax payers may not be the same. Our Tax Relief Modeller can assist with calculations under both UK and SRIT tax regimes. For more info on SRIT and how this works in practice, please visit our facts page.
Eligibility and contributions
Relevant UK individuals
Tax relief is available on pension contributions paid by or on behalf of an individual if he or she is a 'relevant UK individual'. This means:
- an individual under age 75 with earnings chargeable to UK income tax and / or who is UK resident for tax purposes
- an individual, or their spouse / registered civil partner, under age 75 who has earnings for the tax year from an overseas Crown employment
- a non-UK resident individual under age 75 who had earnings chargeable to UK income tax in at least one of the previous five tax years and was UK resident when becoming a member of the pension scheme to which the contribution is being paid.
No tax relief is available on contributions paid by or on behalf of individuals who are not 'relevant UK individuals'.
For tax relief purposes personal contributions include both those paid by the individual member and those paid by a third party for that individual member.
Tax relief is given to the individual – not the third party – and is calculated based on the individual's circumstances. For example, if an individual pays a contribution for an adult child, the amount payable and tax relief will be calculated based on the adult child's income / earnings.
Relevant UK earnings
The levels of tax relief available depend on the member's relevant UK earnings in the current tax year.
These are the earnings available to base a pension contribution on. Generally, all earned income is relevant earnings.
It’s sometimes easier to think about what are not relevant earnings and this includes pension income, dividends and most rental income.
HMRC define relevant earnings as:
- employment income such as salary, wages, bonus, overtime, commission (providing it is chargeable to tax under Section 7(2) ITEPA 2003)
- income chargeable under Part 2 ITTOIA 2005, that is income derived from the carrying on or exercise of a trade, profession or vocation (whether individually or as a partner acting personally in a partnership)
- income arising from patent rights and treated as earned income under section 833 (5B) ICTA 1988
- general earnings from an overseas Crown employment which are subject to tax in accordance with section 28 of ITEPA 2003
- rental income is generally not relevant earnings but some rental income may be included if it is in respect of UK or EEA furnished holiday lettings business
Where relevant UK earnings are not taxable in the UK due to double taxation agreements they are not relevant earnings.
Contributions that are not tax relievable
Not all pension contributions are relievable. The following do not qualify for tax relief for the member;
- contributions after age 75 after 5 April 2007
- new contributions that are life assurance premium contributions
- employer contributions.
If a member has relevant UK earnings of less than basic amount of £3,600 but is making a contribution of more than the level of their earnings, relief at source (RAS) is the only method by which the member can get tax relief on the excess contribution (up to £3,600).
Historical note: contracted out rebates (minimum contributions) did not qualify for tax relief though there is an element of relief included in the rebate amount.
Contribution status of other payments
Transfer values received and pension credit rights received from UK pensions schemes are not contributions.
Transfers of pension credit rights from non-recognised schemes and the transfer of certain shares from ‘save as you earn’ schemes can be treated as contributions and tax relief claimed.
In specie contributions
Contributions must be a monetary amount but it is sometimes possible for a monetary amount to be agreed between the member and the scheme and then the member makes good the 'debt' to the scheme by passing over an asset instead. This is known as an 'in specie contribution'
It is not possible to just contribute the asset at whatever its value may be.
There must be:
- a specified monetary sum, that creates a debt recoverable by the scheme
- a side agreement with the scheme to pay an asset in payment of the debt
- the schemes agreement to accept the asset in lieu of the debt.
This is effectively the scheme acquiring an asset.
If the asset is valued at less than the monetary amount the balance must be paid in cash.
Tax relief works as normal based on the monetary amount.
In specie contributions have been a topic of discussion recently. Providers now have to separate cash and in specie contributions on relief at source claim forms. HMRC have challenged some of the RAS claims for in specie contributions. In Pensions Scheme Newsletter 86 in April 2017, HMRC stated that their position had not changed and remained as stated in PTM042100 which is described above. However, this has been subject to a recent court case and may be subject to change.
Methods of claiming tax relief
There are 3 ways to arrange for tax relief on members' contributions:
- Net pay
- Relief at source
- Assessment – claim to HMRC.
Used by occupational, employer-sponsored, pension schemes where member's contributions are paid over to the administrator by the sponsoring employer.
Under net pay contributions by individuals are deducted by the individual's employer, from his or her salary before tax is calculated.
For example, where an individual wants to pay £1,000 gross the employer would deduct the full amount from salary and pass it to the pension scheme as the individual's £1,000 gross contribution.
In this way, the individual receives tax relief immediately and directly through his or her salary. National Insurance is still payable on the salary though.
In contrast to net pay, contributions paid under relief at source do not reduce the individual's earnings before tax is calculated. The individual's earnings will be subject to deduction of tax in full.
Relief at source
Used by non-occupational pension schemes such as personal pensions, stakeholder pensions and group personal pensions.
Contributions by individuals and third parties are paid net of basic rate tax relief to the scheme and the scheme administrator claims basic rate tax relief from HMRC, which is paid directly into the scheme.
So for every £800 net paid by the individual / 3rd party, HMRC adds £200 to make £1,000 gross.
If the individual is entitled to a rate of tax relief above the basic rate he or she must claim this from HMRC via self-assessment. It’s important to remember that members will only get a rate of relief above basic rate for any taxable income above the basic rate. For instance a member with £1,000 of earnings in the higher rate of tax paying £5,000 gross into a pension scheme operating RAS would only be able to reclaim higher rate relief for the £1,000 that is in the higher rate band of tax.
It can take perhaps up to 10 weeks for the provider to receive the basic rate tax relief from HMRC. However, many schemes / providers will usually gross up the contribution immediately at the time the net contribution is received.
Assessment – claim to HMRC
A claim must be made to HMRC:
- for contributions paid to retirement annuity contracts ('s226')*
- for higher and additional rate tax payers paying contributions via PIRAS (pensions income tax relief at source), relief at source and
- where a member of a scheme operated on the net pay basis wants to pay a contribution that cannot be supported by the earnings in the pay period – eg a single contribution at the end of the tax year.*
*Please note that for members with no taxable earnings (i.e. within the personal allowance) no further claim can be made to the revenue, the only way to obtain tax relief for these members would be a payment to a relief at source scheme.
Level of tax relief
Tax relief is available on the following contributions:
- individuals with earnings chargeable to UK income tax or who are resident in the UK – the greater of £3,600 gross and 100% of UK earnings
- non-UK resident individuals - £3,600 gross.
The £3,600 amount is known as the 'basic amount'. Due to the way tax relief operates those with lower earnings / no earnings can only make use of the £3,600 if paying to a scheme that operates relief at source.
Basic rate tax relief
Anyone under 75 can benefit from basic rate tax relief on some or all of the contributions they pay, regardless of whether or not an individual actually pays any income tax.
Where an individual is restricted to tax relief on £3,600 – either because they are non-UK resident or have earnings below £3,600 – they will be able to receive basic rate tax relief in full on the gross contribution only if the pension scheme operates relief at source.
Higher and additional rate tax relief
Higher and additional rate taxpayers are entitled to tax relief at their highest marginal rate of tax. This does not necessarily mean that an individual will receive higher or additional rate tax relief on the whole of the contribution.
The tax relief is limited by the amount of an individual's income that falls within the higher or additional rate tax bracket.
For schemes operating relief at source, the additional tax relief is given by extending the basic and higher rate tax bands by the amount of the gross pension contribution (ie the individual's net contribution plus the basic rate tax relief paid to the scheme by HMRC).
The thresholds may only be extended by up to 100% of the members relevant earnings.
Some example calculations
Example 1 – client lives in England
- Higher rate taxpayer
- Gross pension contribution - £10,000
Under relief at source, the overall tax position would be:
- Higher rate taxpayer who lives in England
- Gross pension contribution – £20,000
Under relief at source the overall tax position would be:
In this scenario, the impact of the pension contribution is that it removes the member from the higher rate band.
Annual allowance and tapered annual allowance
These are covered fully in our Annual Allowance Facts article. Although the annual allowance and tapered annual allowance don’t directly impact on the tax relief given on pension contributions, they do impact on the effective rate of tax relief by the application of an annual allowance charge. Tax relief is given in full and claimed on the self-assessment in the usual manner. However, where the annual allowance (or tapered annual allowance) is breached there will be a separate charge which will clawback some of the relief gained.
Excess contributions paid in error
Where an individual mistakenly contributes more than 100% of earnings or £3,600, for example a self-employed person who cannot be sure of their total profits for the year, it is possible to claim a refund of contributions paid that were not eligible for tax relief – ie the excess over the greater of 100% of earnings and £3,600. The rules of the scheme will determine whether the refund is allowed or not.
The individual can claim a refund within six years of the end of the tax year in which the contributions were made.
The refund is called a refund of excess contributions lump sum, find out more from HMRC
Where an individual or an employer makes a payment to a pension scheme that is returned to them, it may constitute an unauthorised payment.
An error payment is a payment that the scheme has no right to hold and is therefore neither an authorised payment nor an unauthorised payment, ie it’s not a pension contribution within the meaning of the Taxes Acts / Finance Act.
In this case, the error payment (gross) may be returned to the employer without it being treated as an unauthorised payment. The following are examples of valid error payments given by HMRC:
- the scheme only provides for contributions to be made while the member is in service of the relevant employer,
- any payment made after the cessation of the member's employment, where the terms of employment set out that contributions cease upon cessation of employment,
- failure of a bank/building society to cancel a standing order/direct debit after being instructed to do so, or
- where an employer incorrectly calculates the pension contribution or deducts the wrong rate of contribution under the scheme rules.
If the employer has obtained tax relief to which it is not entitled to receive, they must rectify this.
HMRC also allow a refund of contributions where membership of a policy / scheme has been cancelled within the 'cooling off' period specified by the appropriate regulatory body. In this case, prior approval from HMRC is not required.
Finance Act 2004 -
Section 188 (Relief for contributions)
Section 189 (Relevant UK Individual)
Section 190 (Annual limit for relief)
Section 191 (Methods of giving relief)
Section 192 (Relief at source)
Section 193 (Relief under net pay arrangements)
Section 166 & Paragraph 6 Schedule 29 (Refund of excess contributions lump sum)