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Tax Relief on Workplace Pension Contribution

What is Tax Relief on Pension Contribution?

To be eligible for tax relief you first need to enrol for pension, which is normally done through your employer. If you are aged between 22 and state pension age and earn more than £10,000 per year, then you will be automatically enrolled for workplace pension by your employer. But if you are under 22 or earn less then £10,000 you can still join the workplace pension, but this is optional to you. As of now, the pension contribution is 8% on your pensionable earnings in which the employee contributes 5% and the employer 3%.

Pensionable Earnings are the earnings on which the above 5% & 3% pension rates apply. Some employers use the total gross pay as pensionable earnings while others use Gross Pay minus £6,240 (pension free earning limit) as pensionable earnings. For example, if you earn £30,000 for the year, your pensionable earnings would be £23,760 (£30,000 – £6,240).

The tax relief on pension contribution made is the money that would have gone to HMRC as PAYE Income Tax is paid into your pension pot instead. The amount of tax relief you can get depends on the method which your employer used to work out your Pension Contributions. Being an employee, you cannot choose the method type as it is uniform for the whole organisation. But you can ask the HR department or accounts department whoever does the payroll for your employer to find out which method is being used to work out pension contributions.

The two methods to work out Pension contributions and hence tax relief are:

  1. Relief at Source
  2. Net Pay arrangement


Relief at Source

This is the most used method to work out pension contributions for employees. The way this method works:

  • The employer deducts the PAYE Income Tax as normal on your taxable earnings.
  • And then from the net pay after-tax deduct the 80% pensions contribution on your pensionable earnings and send this to the pension provider.
  • The Pension provider then claims 20% as tax relief from HMRC. (If you are in Scotland and pay tax at 19% you can still get 20% tax relief on your pension contribution).
  • You pay more tax under this method as your pension is deducted after paying the Income tax, but you pay less towards your pension contribution as the government top up the 20%.

Under this method, if you do not pay tax because you earn less then tax-free annual allowance you can still get the 20% relief towards your pension contribution.

As under this method, you pay 80% towards pension and the Pension provider claims 20% from the government. Therefore, the people whose earnings fall under higher rate or additional rate tax band, have to claim additional tax relief separately, either through their self-assessment tax return if they file one or by contacting HMRC.


Net Pay Arrangement

Under this method, you do not have to make a separate claim for additional relief if you are a higher or additional rate taxpayer. So, it does not matter what band your income falls under as you get the relief before you pay for your PAYE Income Tax.

The way pension contribution works under this method:

  • Your employer deducts the Pension contributions from your gross pay.
  • Once the pension contribution is deducting from gross pay, then PAYE Income Tax is calculated. Which means the taxable earning are lower and you have less tax to pay.
  • Although you pay less tax under this method, you must pay the full amount towards your pension contribution as you cannot claim 20% from the government.

Under this method, if you do not pay tax because you earn less then tax-free annual allowance your take-home salary is reduced as you contribute in full towards your pension and cannot get the 20% top-up from the government. You can ask your employer to top up, but they are not legally binding to do that.


Do you still have questions?

If you still have any questions or being a start-up company and not sure which method to go for, please feel free to get in touch and we will advise you of the best possible solution after reviewing your situation. Our initial consultation is always free.


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