Self-Assessment Tax Return: Pension Contributions in the UK

Making pension contributions is a widely used strategy in the UK to reduce tax liabilities. When done correctly, pension contributions can be a highly tax-efficient method of lowering one’s taxes. However, the taxation of pensions can be complex, and careful consideration is necessary before planning pension contributions. 

The tax treatment of pension contributions varies depending on the pension scheme, and individuals need to be aware of potential annual allowance charges if their contributions exceed the annual allowance threshold. This article covers these aspects in detail: how pension contributions are taxed and what to consider when planning your contributions. 

Pension Contribution Under Relief at Source (RAS) 

Under relief at source, the pension scheme obtains basic rate tax relief from HMRC to add to the member’s contribution to create the gross contribution in the fund. The basic rate relief is calculated by dividing the net contribution by 80 and then multiplying the result by 20. 

For instance, if a pension member contributes £8,000 to a private pension scheme, the amount paid by the member is a net contribution. The pension scheme will claim the basic rate relief of £2,000 [8000/80*20], and £2,000 will be added to the member’s pension fund. Additionally, the tax bands of the individual are also increased by the gross pension contribution made. In this scenario, the individual’s basic rate and the higher rate bands will be increased to £47,700 (£37,700+10,000) and £135,140 (£125,000+10,000) respectively.  

The pension scheme administrator must make a claim to HMRC for the members making pension contributions. Although the claim can be made each month, the claim is generally made each tax year. 

Eligibility for RAS 

The Relief at Source method for pension contributions applies to members contributing to a registered pension scheme that operates under RAS. A third party, such as a spouse, can also contribute to the member's pension fund.

However, the tax relief on these contributions is granted only to the member on whose behalf the contribution is made.  

Benefits of Using RAS 

When an individual makes contributions under RAS, they will enjoy two major benefits, i.e. increment in their tax bands and preserving personal allowances.  

The normal tax band for a taxpayer in the UK is £37,700 for basic rate taxpayers, £125,140 for higher rate taxpayers and taxpayers with income over £125,140 are taxed as additional rate taxpayers. One method of expanding this band is via pension contributions under RAS. Individuals making pension contributions under RAS will have their tax bands increased by the ‘gross’ contribution.  

Where an individual net adjusted income exceeds £100,000, their personal allowance will reduce by £1 for each £2 over this income, meaning the complete loss of allowance for an individual with income over £125,140. However, if an individual makes pension contributions under RAS, the adjusted income will fall by the gross contribution made, and the loss of personal allowance may be prevented to some extent. 

Pension Contribution Under Net Pay Arrangements 

Where a member of a pension scheme has an employer operating the net pay arrangement, the pension contributions will be given by payroll deduction. Unlike the RAS method, the amount paid by a member is the gross contribution, meaning that the scheme administrator will not be able to claim the basic rate relief from HMRC. Instead, the contribution is deducted from the employee’s gross pay before it is taxed. Subsequently, the employer operates ‘PAYE’ on the deducted amount of pay.  

Once relief is given under the Ney pay arrangement, the relief will not be given on other provisions to ensure members do not get double tax relief. Unlike the RAS method, no claim is necessary to receive the tax relief. The members effectively receive the full tax relief as the contribution is taken from the member’s pay before the tax is calculated. 

Let’s go back to our earlier scenario and change the figures a bit. If the pension member had a taxable income of £75,000 and chose to contribute £10,000 by the Net pay arrangement instead of the RAS. He would receive the relief as follows: 

Eligibility for Net Pay Arrangements 

Not all pension schemes can use the Net pay arrangements. To qualify for making contributions under this arrangement, schemes must meet specific criteria, which generally apply in two scenarios: 

Occupation Pension Schemes 

• The pension scheme is an occupational pension scheme.
• All the contributing members who are employees of the same employer are also receiving tax relief under the same arrangement. 

Public Service Pension Scheme 

• The pension scheme is a public service pension scheme or a marine pilots’ benefit fund. 
• The member is an employee. 

Tax Return and Annual Allowance 

Individuals making pension contributions must declare the contributions in their Self-Assessment Tax Return. The declaration is not necessary where the contributions are made from the Net Pay Arrangements, and the tax is deducted, but any contributions made under RAS must be shown in the tax return. The amount that should be included in the tax return is the grossed-up figure and not the net figure paid by an individual. 

This is included to calculate if there is any Annual Allowance charge applicable. The annual allowance is charged on the pension contributions in excess of the annual allowance in a year. For the year 2024/25, the annual allowance threshold is £60,000. However, if there is any unused annual allowance from the previous three years, it is possible to carry those forward in the current year. The annual allowance is further reduced for taxpayers whose ‘threshold income’ and ‘adjusted income’ are over 200,000 and 260,000, respectively. 

It is the responsibility of the taxpayers to calculate the annual allowance charge and enter it into the tax return. 

Conclusion 

Pension contributions offer significant tax advantages but require careful consideration and planning. Understanding the differences between Relief at Source and Net Pay arrangements, as well as the implications of exceeding the annual allowance, is crucial for maximising tax benefits. 

By correctly declaring pension contributions and being aware of the annual allowance charges, individuals can effectively reduce their tax liabilities and optimise their retirement savings.