Why pensions are so tax-efficient
Pension contributions attract income tax relief — meaning HMRC effectively tops up everything you put in. A basic-rate taxpayer contributing £80 will have their pot topped up to £100 by HMRC. A higher-rate taxpayer can claim even more back, making pensions one of the most tax-efficient ways to save for retirement.
Pension growth is also free of income tax and Capital Gains Tax inside the wrapper, and you can take 25% of your pot tax-free (up to a maximum of £268,275) when you retire.
Relief at source vs net pay
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Calculate your pension tax relief →The way pension relief works depends on how your employer and scheme are set up:
Relief at source: You contribute from net (post-tax) pay. The pension provider claims basic-rate tax relief directly from HMRC and adds it to your pot. If you're a higher or additional-rate taxpayer, you need to claim the additional relief through Self Assessment or by contacting HMRC. Used by most personal pensions and SIPPs, and by some workplace schemes.
Net pay arrangement: Contributions are deducted from your gross (pre-tax) pay before income tax is calculated. You automatically get relief at your marginal rate. No separate claim needed. Used by most salary-sacrifice workplace schemes and many employer pensions.
How much relief do you get?
| Tax status | Your contribution | Total in pension | Effective cost to you |
|---|---|---|---|
| Basic-rate (20%) | £80 | £100 | £80 |
| Higher-rate (40%) | £80 | £100 | £60 (after claiming extra relief) |
| Additional-rate (45%) | £80 | £100 | £55 (after claiming extra relief) |
Higher and additional-rate taxpayers must actively claim the extra relief — it won't be applied automatically if you're in a relief-at-source scheme. Do this via Self Assessment, or by calling HMRC to adjust your tax code.
The annual allowance (2025–26)
The annual allowance is the maximum amount you (and your employer) can contribute to your pensions in a tax year and still receive tax relief. For 2025–26 it is £60,000 (or 100% of your UK earnings, whichever is lower). Contributions above this limit are subject to a tax charge (the annual allowance charge) at your marginal income tax rate.
Higher earners may face a lower "tapered annual allowance". If your "adjusted income" is above £260,000, your annual allowance reduces by £1 for every £2 over that threshold, down to a minimum of £10,000.
Carry forward
If you didn't use all of your annual allowance in the past three tax years, you can carry forward the unused amount and use it in the current year. This allows large one-off contributions — useful for business owners, those receiving bonuses, or anyone who wants to make a catch-up contribution before retirement. You must have been a member of a registered pension scheme in the year you're carrying forward from.
The Money Purchase Annual Allowance (MPAA)
Once you start drawing flexible income from a defined contribution pension (e.g., taking a flexible drawdown), your annual allowance for future money purchase contributions is reduced to £10,000. This prevents people from recycling pension money back in for repeated tax relief. The MPAA does not apply if you take a tax-free lump sum only, or if you're in a final salary (defined benefit) scheme.
The lifetime allowance — abolished
The lifetime allowance (previously capping total pension savings at around £1 million) was abolished from April 2024. There is now no limit on how much can be held in a pension — though the 25% tax-free lump sum remains capped at £268,275.