There are two broad types of pension schemes from which an individual may eventually be in receipt of a pension:

  • Workplace pension schemes
  • Personal Pension schemes.

A Workplace pension scheme may either be a defined benefit scheme or a money purchase scheme. These days the cost of running a defined benefit scheme which pays a retirement income related to the amount of your earnings, is too expensive and so is not covered. All employers are required to provide a workplace pension scheme due to auto-enrolment legislation and these are nearly all money purchase schemes.

A money purchase scheme instead reflects the amount invested and the underlying investment fund performance. This can come in many forms, be it an individual investment with a large pension provider, part of a company scheme or a self invested personal pension (SIPP).

We set out below the tax reliefs available to members of a money purchase Workplace scheme or a Personal Pension scheme. It is important that professional advice is sought on pension issues relevant to your personal circumstances.

What are the tax breaks and controls on the tax breaks?

To benefit from tax privileges all pension schemes must be registered with HMRC. For a Personal Pension scheme, registration will be organised by the pension provider.

A money purchase scheme allows the member to obtain tax relief on contributions into the scheme and tax-free growth of the fund. If an employer contributes to the scheme on behalf of an employee, there is generally no tax charge on the member and the employer will obtain a deduction from their taxable profits.

When the ‘new’ pension regime was introduced from 6 April 2006 no limits were set on either the maximum amount which could be invested in a pension scheme in a year or on the total value within pension funds. However two controls were put in place in 2006 to control the amount of tax relief which was available to the member and the tax-free growth in the fund.

Firstly, a lifetime allowance was established which set the maximum figure for tax-relieved savings in the fund(s) and must be considered when key events happen such as when a pension is taken for the first time. The lifetime allowance has recently been cancelled so in theory any level of fund can be achieved but it may come with limitations.

Secondly, an annual allowance sets the maximum amount which can be invested with tax relief into a pension fund. The allowance applies to the combined contributions of an employee and employer. Amounts in excess of this allowance trigger a charge.

There are other longer established restrictions on contributions from members of money purchase schemes (see below).

Key features of money purchase pensions:

  • Contributions are invested for long-term growth up to the selected retirement age.
  • At retirement (which may be any time from the age of 55) the accumulated fund is generally turned into retirement benefits – an income and a tax-free lump sum.
  • Personal contributions are generally payable net of basic rate tax relief, leaving the provider to claim the tax back from HMRC.
  • Higher and additional rate relief is given as a reduction in the taxpayer’s tax bill. This is normally dealt with by claiming tax relief through the self assessment system.
  • Employer contributions are payable gross direct to the pension provider.

Persons eligible

All UK residents may have a money purchase pension. This includes non-taxpayers such as children and non-earning adults. However, they will only be entitled to tax relief on gross contributions of up to £3,600 per annum.

Relief for individuals’ contributions

An individual is entitled to make contributions and receive tax relief on the higher of £3,600 or 100% of earnings in any given tax year. However, tax relief will generally be restricted for contributions in excess of the annual allowance.

Methods of giving tax relief

Tax relief on contributions is given at the individual’s marginal rate of tax.

An individual may obtain tax relief on contributions made to a money purchase scheme in one of three ways:

  • A net of basic rate tax contribution is paid by the individual with higher or additional rate relief claimed through the self assessment system.
  • A net of basic rate tax contribution is deducted from net pay of the employee. The contribution is then paid over by the employer to the scheme. Higher or additional rate relief is claimed through the self assessment system.
  • A gross contribution is deducted from the employee’s gross salary and paid by the employer to the scheme. This lowers the employee’s PAYE tax bill and no further action is needed by taxpayers as the correct relief has been given through the payroll.

In the first two ways the basic rate is claimed back from HMRC by the pension provider.

One effective route for an employee to consider may be to enter a salary sacrifice arrangement with an employer. The employer will make a gross contribution to the pension provider and the employee’s gross salary is reduced. This will give the employee full income tax relief (by reducing PAYE) but also reduces National Insurance contributions.

The Annual Allowance

The annual allowance has been £40,000 in recent years including 2022/23 but it has increased to £60,000 for 2023/24 onward. Any contributions in 2023/24 in excess of the £60,000 annual allowance are potentially charged to tax on the individual as their top slice of income. Contributions include contributions made by an employer.

The stated purpose of the charging regime is to discourage pension saving in tax registered pensions beyond the annual allowance. Most individuals and employers actively seek to reduce pension saving below the annual allowance, rather than fall within the charging regime.

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