Pensions: the most generous tax relief around?

I have been professionally involved with pensions for 24 years. 

I have lost count of how many times rules have changed over that period – usually not for the best. 

Yet, despite all the tinkering, overly complex rules and restrictions, pensions still offer one of the most generous sets of tax relief available, in my view. 

You could get up to 45% tax relief on the way in, tax-free growth whilst your money is invested and up to 25% tax-free cash when you take money out. Plus, under current rules, pensions are not typically subject to inheritance tax. 

With fiscal pressure at a record high this array of tax reliefs could make pensions particularly attractive.

Please note: this article gives a very concise overview of complex rules and doesn’t cover all scenarios or exceptions – for example, it does not cover the tax relief position in Scotland, nor the rules for defined benefit pensions. If you are unsure how the rules may apply to you, please seek specialist advice. Tax rules can change and benefits depend on circumstances. 

Up to £4,500 income tax relief for every £10,000 invested

The income tax relief when you invest could be a real boon, especially at a time when a record 6.5 million people face paying the higher and top rates of tax. 

For most investors under age 75, when you make a payment of £8,000 to a pension, the government automatically adds £2,000 (20%). In addition, if you are a higher or top-rate taxpayer you can claim back up to an extra 20% or 25% respectively. The higher the rate of tax you pay, the more tax relief you could receive.

The result is remarkable: a £10,000 contribution could effectively cost a higher-rate taxpayer as little as £6,000, reducing to £5,500 for a top-rate taxpayer.

If you are a UK resident under age 75 and have an earned income, you should be able to benefit in some measure: in many cases, this tax year you can contribute as much as you earn, capped at £60,000 – and you could benefit from up to £27,000 tax relief. 

There are situations when the maximum you can contribute is lower – and consequently so is the tax relief you could receive. 

Broadly speaking, you can contribute progressively less when your “adjusted income” (your income plus any money you or your employer have added to your pension) is more than £260,000. Once it reaches or exceeds £360,000, you can contribute a maximum of £10,000 – read more in our Tapered Allowance factsheet.

Bear in mind, too, it may also be possible to make pension contributions over your Annual Allowance by ‘carrying forward’ unused allowance from the previous three tax years – read more in our Carry Forward factsheet.

A reduced £10,000 limit, known as the Money Purchase Annual Allowance or MPAA, may also apply if you have taken taxable money out of your pension since 2015, using the pension freedoms – read more in our Money Purchase Annual Allowance factsheet.

Despite the allowance being far less generous, if you have earnings to support it you could have £10,000 invested and working for you at an effective cost of as little as £5,500. 

If you don’t have any earnings, or earn less than £3,600 a year, you should still be able to contribute up to £3,600 this tax year – a payment of £2,880 to which the government adds £720 basic tax relief. 

No Lifetime Allowance – why might it still matter?

The Lifetime Allowance previously set the limit of total value that could be built up in pensions without incurring a tax charge. It has been abolished from 6 April 2024.

In theory, this means there are no longer limits on how large a pension you can build. However, in practice, the rules are not as straightforward for those wishing – and able to – build a large pension, as new rules have been introduced, limiting the total amount of tax-free cash you can take in your lifetime and you can pass on when you die.

A new Lump Sum Allowance (LSA), effective from 6 April 2024, limits the tax-free cash you can get from your pension to £268,275. Meanwhile, a second new allowance, the Lump Sum and Death Benefit Allowance (LSDBA) – also effective from 6 April 2024 – limits the total amount of tax-free cash you can take in your lifetime and you can pass on when you die to £1,073,100, in most cases. 

So, if you build a large pension, a greater proportion may be taxed when you take the money out, making pensions progressively less tax efficient, the larger the pot you build. Different limits may apply if you have previously applied for Lifetime Allowance Protection (you should have a certificate from HMRC to this effect or can check via your online HMRC account). If you have protection, it could be sensible to take advice before making any decisions that could impact it.

Investment ideas for your pension 

Once you decide to contribute to a pension, the next question is probably where to invest. 

We have two ready-made investment ideas for you to consider: the Quality Shares Portfolio and the Wealth Club Portfolio Service. Both are designed specifically for wealthier and more experienced investors and are exclusive to Wealth Club. We manage the portfolios for you but the service is not personal investment advice.

Note: these discretionary managed portfolios are long-term investments which can fall as well as rise in value and returns are not guaranteed.  Currently, these two ideas are not available if you are in drawdown or intend to take benefits from the pension soon, however we are working on making these options available.