How your pension contributions can improve your tax efficiency 


How your pension contributions can improve your tax efficiency 

Becoming tax-efficient

If you make personal contributions to your pension whilst you are earning a salary, you will add value to your retirement by putting money aside and getting tax breaks benefits for doing so. 

When you contribute via an employer pension, this personal contribution is deducted from your gross salary before tax and National Insurance is applied. Your employers are also legally required to make a contribution unless you choose to ‘opt out’.  

If you contribute via a personal pension, you get a 20% tax relief added to the contribution and for higher and additional rate taxpayers you can claim the additional tax back via a self-assessment.

Any money invested in a pension can effectively grow tax-free without the need to declare capital gains or dividends, whilst it remains within the pension structure.  

I will give you an example to make things easy. 

If an individual earns £60,270pa they are a higher rate taxpayer. If they put £10,000 (gross) into their pension via salary sacrifice they will get the full £10,000 to invest. However, if they take the money as their income, they will pay 40% tax and National Insurance which is now at 3.25% for above the upper earning threshold leaving that individual with only £5,675 of their £10,000.  

Additionally, this individual should also get a contribution from their employer which will increase that £10,000. At retirement, they will be entitled to 25% of this money tax-free and then can draw the remaining 75% tax efficiently. This money can grow during the period it is in a pension without having to declare tax.   

Rules that you need to be aware of to ensure tax efficiency remains:

  1. Your annual allowance, which is the limit you can contribute to a pension during a tax year and remain tax efficient. You are allowed to put 100% of your relevant earnings for the tax year into a pension, up to £40,000, and receive tax relief. Non-earners can contribute £3,600 (gross) to their pension and very high earners will see their Annual Allowance tapered down.   


  1. Money Purchase Annual Allowance (MPAA): Anyone deemed to have flexibly accessed their pension i.e. they have taken income via flexible drawdown or a flexible annuity beyond their tax-free cash limit will have triggered the MPAA. This reduces their Annual Allowance down to £4,000. Therefore, an individual using their pension income for a period and then returning to employment needs to be careful to not exceed this allowance as they may be automatically enrolled into a pension. Individuals taking pension income alongside earning also need to be careful. On this website, you can check if you’ve gone above the money purchase annual allowance.


  1. Carry Forward: If you exceed your Annual Allowance or MPAA then additional tax will have to be paid. However, if you have not fully utilised your annual allowance in the previous three years you might be able to carry forward your unused annual allowance meaning you can potentially contribute more than the £40,000 for one tax year.   


I have put an example in the table below: 

Tax year 2019/2020 2020/2021 2021/2022 2022/2023
Pension Contribution £12,000 £8,000 £20,000 £100,000 (£80,000 used against the previous 3 years)
Annual Allowance £40,000 £40,000 £40,000 £40,000
Unused Annual Allowance £28,000 £32,000 £20,000 £20,000
Cumulative Annual Allowance carried forward £28,000 £60,000 £80,000 £20,000

You will see that the above individual has managed to use their past 3 years’ worth of cumulative unused annual allowance to make a much larger pension contribution this tax year and not exceed their Annual Allowance for 2022/23.

I know this could sound complicated, and if that is the case, you should seek advice when using carry forward, which your Tideway Wealth Manager will be able to help with. 

Tax efficiency and Tapered Annual Allowance (TAA):

If you earn over £240,000 per annum as total income, you should be careful as you will start losing your Annual Allowance. You have to consider all sources of income, including pension contributions, bonuses, investment income, property income etc. 

The rule says that for every £2 over the £240,000 that an individual earns their Annual Allowance is reduced by £1, this goes all the way down to a minimum of Tapered Annual Allowance of £4,000.  

Anyone earning over £200,000 and contributing to a pension should look into this as the rules are complicated around your adjusted and threshold income.  

If you don’t look into this can lead to an unexpected tax bill in the post. 

It is also worth noting that this rule changed in 2020 having been introduced in 2016, where it had previously been a problem for those earning over £110,000. So, if you do earn between £100,000 and £200,000 this may no longer be a problem for you.  

Tax efficiency and Lifetime Allowance:

The other key threshold where a pension loses its tax efficiency is the lifetime allowance (LTA) which you can learn more about here. Each individual can build up £1,073,100 in their pension tax-efficiently, if you do exceed this amount, you will potentially have to pay additional tax. 

In this article about Tax-Efficient Income, you can also learn about withdrawing your pension tax efficiently. 

If you are interested to know more about the content of this note and doing something about it or even for a family member, do get in touch with your Wealth Manager.  

Alternatively, why not to book a free session with one of our Advisers who will happily talk you through the options. At Tideway we have a number of experienced Chartered Financial Planners and Wealth Advisers who can work together with you and find an appropriate solution based on your personal circumstances.