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Workplace Pensions: Understanding the Two Forms of Tax Relief Available 

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Introduction to Workplace Pensions and Tax Relief

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When planning for a secure financial future, your workplace pension is crucial. You are entitled to tax relief on any pension contributions made by yourself out of your income and this can significantly increase your pot for when you retire.  

Due to Automatic Enrolment legislation, most workers will now be making contributions to a workplace pension unless they have opted out. This article breaks down the two main forms of tax relief – ‘Net Pay’ and ‘Relief at Source’ – to help you understand their workings and benefits. 

Net Pay Arrangement 

In a ‘Net Pay’ arrangement, contributions are deducted from your salary before income tax is applied. This method ensures you receive full tax relief upfront, regardless of whether you are a basic, higher, or additional rate taxpayer.  

On Your Payslip: Your contribution amount after tax relief is applied, which means you will see immediate tax savings. 

Example: 

If your pay before contributions is £2,500 and you make contributions of £100, your tax will be calculated on £2,400 of income only, giving you full immediate relief at your marginal tax rate. Your pension pot will increase by £100 with no additional amounts claimed by the Pension Scheme. Please note that pension contributions have no impact on any national insurance charged. 

Until 5th April 2024, those earning below the tax threshold (£12,570 for tax year 2024/25) will not benefit from this arrangement, as their earnings are not subject to income tax. 

Going forward, they will instead receive a top-up payment from HMRC after the end of each tax year. This prevents low earners from being disadvantaged compared to those under Relief at Source arrangements. 

This arrangement can be favourable for higher earners, as they maintain a healthy cashflow without informing HMRC and do not have to reclaim their tax relief later.  

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Relief at Source Arrangement 

‘Relief at Source’ works by deducting pension contributions after your salary is subjected to tax and National Insurance. The pension provider then adds tax relief at the basic rate to your pension pot. 

On Your Payslip: Your payslip under this scheme shows only your contribution amount. The tax relief, claimed by your pension provider, directly increases your pension pot. 

Claiming Additional Relief 

If you are a higher or additional rate taxpayer, you will be eligible to claim back more than the basic rate tax relief granted. This requires you to file a claim through your tax return, providing an opportunity to maximise the value of your pension contributions. If you do not submit tax returns, then you should contact HMRC to ensure you get full relief for the Pension Contributions made through a change in your tax code 

Example:

If you make an £80 contribution from your wages after tax, the Pension Scheme will reclaim £20 basic rate relief to add £100 to your pension pot. 

However, if you are a higher or additional rate payer you have had £40/£45 deducted from pay, leaving you £20/£25 short. You are still entitled to this relief; however, this process is not automatic and requires a tax return submission or change in your tax code. Once you have received the relief it will have cost you £60/£55 to contribute £100 into your pension. 

Those earning less than the personal allowance will still get the pension top-up despite not having suffered a tax deduction. 

Your Pension Statement 

Your pension provider sends an annual statement showing your pension pot’s value. It offers an estimate of the amount you are likely to receive upon retirement. Your payslip reflects the contributions towards your pension, incorporating the tax relief you have gained. It is advisable to examine your payslip each month to ensure your own and your employer’s contributions are accurate.  

Conclusion: Do Not Miss Out On Tax Relief! 

Always consult with your employer or pension provider to confirm which tax relief arrangement your workplace pension uses. 

If you are making pension contributions under a Relief at Source arrangement and you are a higher or additional rate taxpayer, then you will be overpaying tax unless you are informing HMRC of these contributions. 

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