How does pension tax relief work?
SIPP tax relief is essentially a government contribution to your pension. It is designed to encourage saving for the future.
The government pays at least 20% of the total amount you invest in your SIPP.
For example, if you pay £800 into your SIPP, the government will top it up to £1,000. They pay 20% of the £1,000 total – a £200 contribution.
Essentially, every 80p you pay in is topped up to £1.
Claiming your tax relief
The amount of SIPP tax relief you can receive depends on your income tax band.
Your provider will always claim 20% tax relief for you as standard.
Higher-rate or Additional-rate taxpayers can claim back an extra 20% or 25% through their self-assessment tax returns.
The table shows the total cost of contributing £1,250 to a SIPP at different rates of tax relief.
Tax relief rates
Tax relief effectively means that the government returns some of the income tax you have paid as a pension contribution.
Tax relief rates are:
- 20% for basic-rate taxpayers
- 40% for higher-rate taxpayers (anyone earning over £50,000 annually)
- 45% for additional-rate taxpayers (anyone earning over £150,000)
Income tax in Scotland is banded differently.
Scottish income tax rates are:
- 20% for basic-rate taxpayers
- 21% for intermediate-rate taxpayers
- 41% for higher-rate taxpayers
- 46% for additional-rate taxpayers
If you are a Scottish taxpayer, your provider will still claim the first 20% automatically, but you will need to claim the remaining 1%, 21% or 26%.
What if I have no earnings?
If you are a non-taxpayer – e.g. if you are unemployed - you can still qualify for tax relief on annual contributions up to £3,600.
This is equivalent to a personal contribution of £2,880 and tax relief of £720 (20%).
SIPP annual allowance
You can invest up to 100% of your earnings in a SIPP each tax year (capped at £40,000).
Because of tax relief, this actually means you can contribute up to £32,000 of your own money, and receive up to £8,000 in tax relief.
If you have an income of £200,000 or more, you may be subject to a tapered annual allowance.
Your annual allowance will reduce by £1 for every £2 that your ‘adjusted income’ exceeds £240,000.
If your adjusted income reaches £312,000, you will be subject to the maximum £36,000 reduction in annual allowance. That means your annual allowance would be reduced to £4,000.
Carry forward rule
If you have not used your full allowance in any of the previous three years, you may be able to carry over some of your SIPP annual allowance.
This is called the ‘carry forward’ rule.
To be eligible, you must have:
- been a member of a pension scheme in each tax year from which you carry forward.
- used up your full annual allowance in the current tax year.
- contributed less than £40,000 in one or more of the last three tax years. (including personal and employer contributions.)
- earned at least the amount you are contributing in that tax year, if you are making personal contributions.
Tax relief after starting income drawdown
Once you have started to drawdown income from your SIPP, your annual contribution allowance reduces to £4,000. This is called the Money Purchase Annual Allowance (MPAA). Because of tax relief, this actually means you can contribute up to £3,200 of your own money and receive up to £800 in tax relief.
This means you will not receive tax relief on annual contributions over £4,000.
The MPAA will not be triggered if you have only taken your tax-free lump sum from your SIPP, it is only triggered once income payments commence.
Tax relief FAQs
What is the lifetime allowance?
The lifetime allowance on pensions is the total amount you can withdraw from a pension without paying additional tax.
The current lifetime allowance for 2020/21 is £1,073,100.
What is the Money Purchase Annual Allowance (MPAA) and how does it get triggered?
If you start drawing money from a pension (not including your tax-free lump sum), the amount you can contribute into your pension and still receive tax relief is reduced. This is known as the Money Purchase Annual Allowance, or MPAA.
This tax year, the MPAA is £4,000. It means that in drawdown, you can continue to contribute up to £3,200 of your own money and receive up to £800 in tax relief.
What happens to tax relief if my income is over £200,000?
If you earn over £200,000 a year, you will be subject to a tapered annual allowance.
In short, this means the total you can pay into your pension and receive tax benefits is reduced, depending on how much you earn over the limit.
For every £2 you earn above £240,000, the annual allowance is reduced by £1. If your adjusted income reaches £312,000, you will be subject to the maximum £36,000 reduction in annual allowance. That means your annual allowance would be reduced to £4,000.
Open a SIPP by 31 December and pay no SIPP fee until July 2021.
This means your service plan fee of £9.99 covers you for all of your investment accounts. Following the offer period, the ii SIPP fee is only £10 a month more, and could save thousands compared to other pension providers who charge a percentage fee. Terms apply