Pension schemes and tax - the basics

You can pay as much as you like into your pension scheme, and there's no limit on how much pension you can get. However, there's a limit on how much tax relief you get. How pension scheme payments are taxed depends on the type of payment being made.

On this page:

Pension schemes and tax relief

Pension schemes that are registered with HM Revenue & Customs (HMRC) can qualify for tax relief on:

  • pension contributions
  • investment income and gains
  • some lump sums paid from the scheme

Most pension schemes are registered because of the tax advantages, but a pension scheme doesn't have to be registered.

Tax relief may be given on employer contributions to a non registered pension scheme, but there's no tax relief on:

  • employee contributions
  • investment income and gains

Payments from a non-registered scheme, including lump sums, are taxable.

Technical guidance on the tax treatment of non-registered pension schemes

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Tax relief on contributions

There's no limit on the amount of contributions either a member or an employer can pay into their pension scheme.

Tax relief on member contributions is limited to 100 per cent of your earnings. If you earn less than £3,600 you can get tax relief on contributions up to that amount as long as the scheme uses the relief at source method for giving tax relief - more in the link below.

Employers may get tax relief on contributions they make in respect of their employees. Tax relief on large employer contributions may be spread forward over up to four tax years.

Tax relief on pension contributions

Relief at source for pension schemes

Technical guidance on employer contributions

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Annual allowance

Although there's no limit on the amount you can pay into your pension scheme there's a limit on the amount of pension savings you can build up each year that benefits from tax relief. This is called the annual allowance. If your pension savings for the year are more than the annual allowance you'll pay tax on the excess.

Use the link below to find out:

  • how the annual allowance affects you, including when you can carry forward unused annual allowance from a previous tax year
  • how to work out the tax due on amounts above the limit

Understanding the annual allowance for pension schemes

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Lifetime allowance

Although there's no limit on how much pension you can be paid there's a limit on the amount of pension savings you can build up over your lifetime that benefits from tax relief. This is called the lifetime allowance. At certain points the amount of your pension savings will be tested against the lifetime allowance. This normally happens when you start taking your pension. If your pension savings are more than your lifetime allowance tax is due on the excess. This tax is payable by both you and the scheme administrator.

Understanding the lifetime allowance for pension schemes

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Pension scheme investments

The income and capital gains of most pension scheme investments qualify for tax relief. Pension schemes can invest in whatever they like, but if certain conditions aren't met there may be tax charges on the investment. There are extra conditions on investments made by investment-regulated pension schemes where the member has the ability to choose how their own pension pot is invested.

In deciding how a scheme investment will be taxed you need to consider:

  • what the scheme is investing in
  • if the scheme is an investment regulated pension scheme and if it is, would the investment be classed as 'taxable property'

Pension scheme investments and tax

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Unauthorised payments

As a condition for providing tax reliefs to pension schemes, the government wants them to use their funds to provide you with certain benefits such as a pension for life. The tax rules refer to these benefits as authorised payments and specify the conditions that need to be met for payments to be authorised. Any other payment is classed as unauthorised and tax charges are payable.

Certain scheme transactions are also unauthorised payments.

Unauthorised payments are subject to the following:

  • a tax charge of at least 40% on either the member or the employer
  • a tax charge of between 15 and 40%, called the scheme sanction charge, on the scheme administrator

Unauthorised payments from pension pots

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Payments from your pension scheme

You must normally be aged at least 55 before you start taking your pension. You may be able to start your pension earlier if you're retiring due to ill health or were a member of your scheme on 5 April 2006 and have what is known as a protected pension age.

Your pension should give you a pension payable for life. Depending on the type of pension scheme you belong to you will have various options as to how you take your pension.

Your pension will be taxable. How much tax you'll pay depends on your overall taxable income after your tax-free allowances.

Your pension will be paid to you by your pension or annuity provider with tax already taken off via the PAYE (Pay As You Earn) System.

Taking your pension before you're 55 using a protected pension age

Taking payments from your pension pot

Tax on workplace, personal or foreign pensions

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Tax-free lump sum on retirement

You're usually able to take part of your pension pot as a tax-free lump sum when you start taking your pension. Your tax-free lump sum cannot be more than either:

  • 25% of the value of pension savings in the scheme that you're putting into pension payment
  • 25% of your remaining unused lifetime allowance (based around the normal £1.25 million lifetime allowance unless you have:
    • primary protection or enhanced protection in which case use £1.5 million
    • fixed protection in which case use £1.8 million
    • fixed protection 2014 in which case use £1.5 million
    • individual protection 2014 in which case use the amount of your protected lifetime allowance (the value of your pension savings on 5 April 2014)

Your pension scheme administrator will be able to tell you what the maximum tax free lump sum payable from their scheme is.

More about tax-free lump sums on retirement

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Short service refunds of contributions

If you withdraw from a workplace pension scheme within two years of joining your scheme may refund your contributions. Certain events may shorten this time limit.

Your scheme administrator will deduct tax before making the refund. Tax is deducted at 20% for refunds of up to £20,000 and at 50% on any excess above this.

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Trivial and winding up lump sums

If your pension pot is small the whole amount may be paid to you as a lump sum. This type of lump sum is often called a trivial lump sum - more in the link below.

You may also have a pension pot of up to £18,000 paid to you as a lump sum if both the following apply:

  • your workplace pension scheme is winding up
  • your employer isn't paying into another pension scheme for you

All or 75% of these lump sums are taxable, depending on whether or not you were previously receiving a pension from your pension pot. How much tax you'll pay depends on your overall taxable income after your tax-free allowances. Your pension scheme administrator will take off tax using the PAYE (Pay As You Earn) System.

Taking a small pension pot as lump sum

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Serious ill health lump sums

You may take all your pension pot as a lump sum if you're retiring due to ill health and you're not expected to live for longer than a year.

If you're under 75 your serious ill health lump sum will be tax free as long as the lump sum together with any benefits already taken from other schemes is no greater than your lifetime allowance. If you have already used up all or part of your lifetime allowance you'll pay a 55% tax charge on either the whole of the lump sum or the amount by which it exceeds your remaining lifetime allowance.

If you're 75 or older, 55% tax is always due on the whole lump sum. The scheme administrator should deduct this tax before paying the lump sum.

More about serious ill health lump sums

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Lump sum death benefits

If you die before you start your pension your scheme may pay a lump sum death benefit. If you die before you're 75 this lump sum is usually tax-free up to your unused lifetime allowance. If the lump sum exceeds your unused lifetime allowance there is a 55% lifetime allowance tax charge on the excess. The tax is payable by whoever receives the lump sum.

If you're 75 or older when you die a special 55% tax charge is due on the whole lump sum. The scheme administrator should deduct this tax before paying the lump sum.

Pension schemes can also pay a lump sum death benefit if you die after you start taking your pension. These lumps sums are also usually taxable at 55%. The scheme administrator should again deduct this tax before paying the lump sum.

What happens to your pension savings when you die

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Dependant's pensions

When you die, your scheme may provide for a pension to be paid to 1 or more of your dependants. These pensions are taxable. How much tax a dependant will pay on their pension depends on their overall taxable income after their tax-free allowances.

The pension will be paid to the dependant by your pension or annuity provider with tax already taken off via the PAYE System.

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