How Pension Contributions Lower Your Tax Bill
Learn how contributing to your pension can reduce your income tax and National Insurance—while boosting your long-term savings.
What you buy for your pension lowers the amount of income tax and National Insurance you pay and adds to your long-term savings.
Whatever contributes to the pension is not just a boon for future use but also a way of lowering the amount of tax liable today. This is how your pension can become one of the most lucrative tax-efficient tools available in your financial kit.
1. Pension Contributions Get Tax-Free Treatment
Once you pay into a pension, you take an initial deduction depending on the highest rate of income tax you pay. The following illustrates:
- Basic rate taxpayers (20%) automatically get 20% tax relief added
- Higher rate taxpayers (40%) can claim an extra 20% via their tax return
- Additional rate taxpayers (45%) can claim an additional 25%
Therefore, for a £100 contribution, depending on your tax bracket, you will find this to cost you only £80 or perhaps even less.
2. Salary Sacrifice Schemes
The various attributes of such a scheme are that, if your employer operates a salary sacrifice pension scheme, then your contributions will be deducted from your gross (pre-tax) salary; thereby, it will help reduce:
- Taxable income
- National Insurance contributions
The employer may also pass on their savings on NI to your pension—thereby, further boosting your pot.
3. Reduce Higher Tax Band Exposure
Pension contributions can lower your income below the higher tax threshold and help you retain your personal allowance, which would otherwise get deducted if you earned over £100,000. For some clever contributions, this could prevent your entry into the 40% or 60% tax bands.
4. What Is The Maximum I Can Contribute?
Contributions can take 100% of annual earnings (up to £60,000) and propel pension tax relief. It is known as the annual allowance. For individuals with an enormous income, tapered restrictions apply.
A Practical Example: Meet Sarah
Sarah earns £70,000 a year and pays income tax at the higher rate (40%). She decides to contribute £10,000 into her workplace pension through salary sacrifice.
So how does that work for her?
- Taxable income is reduced from £70,000 to £60,000
- She avoids tax on some of her higher-rate income
- She saves £4,000 of income tax at 40% of £10,000
- She saves about £600 on National Insurance
- Her take-home pay is reduced by about £5,400, but £10,000 is paid into her pension
And if her employer matches the NI saving into her pension, then all the better. It's win-win—less tax today and more savings in retirement tomorrow.
Try Our Calculator
Find out how pension contributions can affect your take-home pay with our salary calculator. It lets you easily play around with various contribution levels.
FAQ
How do I claim higher-tax relief on my pension?
If you're a higher-rate taxpayer, the basic 20% relief will be added automatically. However, to claim an extra 20% (or 25% if you're an additional rate taxpayer) it must be done through your Self Assessment tax return or by contacting HMRC directly.
What is the pension annual allowance for 2025?
Normal annual allowance is £60,000 or 100% of earnings on whichever is lower. If your earnings exceed £260,000, your allowance may be tapered because of that, down to a minimum of £10,000.
Can I carry forward unused pension allowance?
Yes! Provided you were a member of a registered pension scheme in the relevant year, you can carry forward your unused allowance from the previous three tax years.
Final Tip
Whether you're just starting your career or earning six figures, pension contributions are a powerful way to cut your tax bill today while growing long-term wealth for tomorrow.