Pension tax relief: relief at source vs net pay

Saving into a pension is one of the most tax-efficient things you can do with your pay. The government gives you tax relief on contributions, so £1 in your pension costs you less than £1 of take-home pay. But how you receive the relief depends on how your scheme is set up. This guide explains the two main methods, and what higher-rate and lower-paid workers need to know.

How pension tax relief works

Contributions you make to a registered pension scheme get income tax relief at your highest rate, up to limits. GOV.UK’s guide to tax on your private pension contributions explains the rules. In practice, your scheme will use one of three methods:

• Net pay arrangement: your employer takes the contribution from your pay before working out income tax.
• Relief at source: the contribution is taken from your pay after tax, and your pension provider claims basic-rate relief from HMRC and adds it to your pot.
• Salary sacrifice: you give up part of your salary and your employer pays it into your pension. It isn’t technically tax relief, but the effect is similar, and you save National Insurance too. Our guide to salary sacrifice covers it in detail.

Net pay arrangements

Under a net pay arrangement, your contribution is deducted from your gross pay, and income tax is worked out on what’s left. You get relief at your highest rate automatically, with nothing to claim. National Insurance is still charged on your full pay.

For example, on a £40,000 salary with a 5% net pay contribution, your pension receives £2,000 a year. Your take-home pay falls from £32,320 to £30,720, so the contribution costs you £1,600 of take-home pay.

Relief at source

Under relief at source, your contribution comes out of your pay after tax. Your provider then claims basic-rate relief of 20% from HMRC and adds it to your pot. So for every £80 you pay, your pension gets £100.

On the same £40,000 salary, a relief at source scheme that puts the same gross amount into your pot costs you £1,600 of take-home pay. For a basic-rate taxpayer, that’s the same as the net pay arrangement.

Most personal pensions, stakeholder pensions and SIPPs use relief at source, as do some workplace schemes.

Higher-rate taxpayers

If you pay tax above the basic rate, the two methods differ.

Net pay: you get full relief at your highest rate automatically, because the contribution comes out before tax.

Relief at source: your provider adds only basic-rate relief. You claim the rest from HMRC, either through Self Assessment or by contacting HMRC, which usually adjusts your tax code. On a £60,000 salary with a 5% contribution, the extra relief you can claim is about £600 a year. Many people never claim it, so it’s worth checking.

The extra relief is limited to the amount of your income taxed at the higher rate. Contributions also reduce your adjusted net income, which can help if you’re affected by the High Income Child Benefit Charge or the Personal Allowance taper.

Lower earners

Relief at source is better for people whose pay is below the Personal Allowance of £12,570. They pay no income tax, so a net pay arrangement gives no relief, while relief at source still adds basic-rate relief to the pot.

For example, someone earning £12,000 with a 5% contribution gets £600 into their pension at a cost of £480 under relief at source, but £600 under net pay. HMRC now makes top-up payments to some low earners in net pay schemes, but these are paid after the end of the tax year rather than through your pay.

Scottish taxpayers

If you pay Scottish income tax, the same principles apply but the rates differ. Under relief at source, starter-rate taxpayers still get full basic-rate relief, and intermediate, higher, advanced and top-rate taxpayers can claim extra relief from HMRC. See our guide to Scottish income tax.

Automatic enrolment

If you’re an employee aged at least 22, under State Pension age and earning more than £10,000 a year, your employer must enrol you in a workplace pension. Minimum contributions are often worked out on “qualifying earnings”, the band of pay between £6,240 and £50,270, rather than your whole salary. Your employer must contribute as well, and many pay more than the minimum, sometimes only if you contribute more too. It’s worth checking your scheme’s rules: matching contributions are effectively extra pay. You can choose the qualifying earnings basis in our calculator’s pension options.

Claiming higher-rate relief step by step

1. Check your total gross contributions for the tax year: what you paid plus the basic-rate relief your provider added.
2. If you fill in a Self Assessment return, enter the gross figure in the pension section. HMRC extends your basic-rate band by that amount, which gives you the extra relief.
3. If you don’t fill in a return, contact HMRC or use its online service to claim. HMRC usually adjusts your tax code so you get the relief through your pay.
4. You can usually claim for earlier years too, within the time limits HMRC allows.

Limits on tax relief

You can get relief on contributions up to the amount of your earnings in the year. There’s also an annual allowance for total contributions from you and your employer: above it, you may face a tax charge. High earners may have a lower, tapered allowance. GOV.UK’s pages on the annual allowance set out the current figures and how unused allowance from earlier years can be carried forward.

Comparing your options

Use the salary sacrifice calculator to compare a sacrifice with your current contribution, and our take-home pay calculator to see the effect of each method. Choose the method under “Pension” and enter your contribution as a percentage or a fixed amount. If you’re getting a bonus, the bonus tax calculator shows what happens if you pay part of it into your pension.