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Pensions guarantee some peace of mind for when you retire, allowing you to build up a pot of savings that will provide an income when you're no longer working. Generally, you can access these savings from the age of 55.

But the cost of living isn't cheap, and it's easy to let everyday expenses take priority over long-term saving. For many – and Millennials in particular – instant gratification often wins out. The reason this may severely hinder a Millennial's retirement is an underestimation of the power of compound interest.

This quote, often dubiously attributed to Einstein, sums it up well:

Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn't… pays it.
Compound interest is the most powerful force in the universe.

The good news is the government offers certain tax breaks to encourage people to start building their pensions early on and thus make the most of their savings, particularly when you factor in compound interest. This means that some of the tax you would have paid on your earnings goes into your pension instead. Not bad, right?

Pension tax breaks normally relate with the income tax rate you pay, can be claimed through your workplace pension scheme and do not affect other tax reliefs, such as EIS. We outline how you can make the most of your pension tax relief below.

What is pension tax relief?

Pension tax relief makes it more attractive to save for the future by giving you more bang for your buck now. Since the tax relief you receive on your pension contributions is paid at the highest rate of income tax you pay, the higher your rate of tax, the more you could receive.

This is how that breakdown looks for the UK:


  • Basic-rate taxpayers get 20% pension tax relief: e.g. a contribution of £100 from your salary into your pension would cost you £80, with the government contributing the other £20 – the amount it would have taxed from £100 of your salary
  • Higher-rate taxpayers can claim 40% pension tax relief: e.g. a contribution of £100 costs you £60, with the government adding £40
  • Additional-rate taxpayers can claim 45% pension tax relief: e.g. a contribution of £100 costs you £55, with the government adding £45


  • Starter rate taxpayers pay 19% income tax but get 20% pension tax relief
  • Basic rate taxpayers pay 20% income tax and get 20% pension tax relief
  • Intermediate rate taxpayers pay 21% income tax and can claim 21% pension tax relief
  • Higher-rate taxpayers pay 41% income tax and can claim 41% pension tax relief
  • Top rate taxpayers pay 46% income tax and can claim 46% pension tax relief

Example of pension tax relief for 2018/19

You can receive up to 46% pension tax relief for the 2018/19 tax year by contributing to a pension. Here is an example of how it can work for UK taxpayers (bear in mind the rules are slightly different for Scotland, as outlined above):

  • A basic-rate taxpayer puts £8,000 into their pension. The government tops this up with £2,000, making a total investment of £10,000

What is compound interest?

Compound interest is the reason it really pays to start building your pension early. Effectively, it's the process of your pension fund earning interest on the interest it has already earned. Allow us to illustrate.

Without compound interest, you can put aside £1,000 a year and after five years have a pot of £5,000. This is the saving equivalent of stashing the cash in your sock drawer.

With compound interest, the money tells a different story. Assuming an interest growth rate of 5% per annum, your first year's investment will turn into £1,050, meaning that in Year 2 the amount you've put away becomes £2,050. This total figure grows by 5% again, now totalling £2,152.5. You put in another £1,000, and the exponential growth continues. By the end of the five years, you have £5,801 – that's £801 more than what could have been gathering dust in your sock drawer.

Providing that this interest growth is sustained, the earlier you put your money in, the better. For example, if you wait a year but start of your investment with a contribution of £2,000, and contribute £1,000 for the next three years, you'll still be down from the amount you would have saved had you invested a year earlier. Here Marcin and Ellie can demonstrate, again assuming a stable interest rate of 5%:

Year Ellie Marcin
2014 £1,000 invested --
2015 With interest = £1,050
+£1,000 invested
= £2,050
£2,000 invested
2016 With interest = £2,152.50
+£1,000 invested
= £3,152.50
With interest = £2,100
+£1,000 invested
= £3,100
2017 With interest = £3,310.125
+£1,000 invested
= £4,310.125
With interest = £3,255
+£1,000 invested
= £4,255
2018 With interest = £4,525.63
+£1,000 invested
= £5,525.63
With interest = £4,467.75
+£1,000 invested
= £5,467.75

At the end of the five years, Ellie saves £57.66 more than Marcin. That might not seem like much, but the divide grows the more you put in and can really build up over time.

As with all investments, you do need to remember the caveat that interest rates can change over time, that your investment can go down as well as up in value, and that past performance is no indicator of future performance.

How do I claim pension tax relief?

This depends largely on the type of pension you're paying into; you can find this out by looking at your pension agreement, your contract or consulting your place of work. Sometimes you will need to do a bit of back and forth to ensure you get the full tax relief to which you are entitled.

There are two main ways you can claim pension tax relief…

  1. Pension tax relief from net pay
  • Many workplaces will deduct your pension contributions automatically from your salary before the Income Tax is paid, after which your pension scheme claims back tax relief at your highest rate of Income Tax. This is called a net pay arrangement and doesn't require you to do anything to get your full tax relief.
  1. Pension tax relief at source

If you are paying into your pension straight through your employer, 80% of your total contribution will be taken from your salary net of basic rate tax relief. The remaining 20% will be topped up by HMRC on request from your pension scheme provider.

Am I eligible for additional tax relief?

Depending on when and how your pension contribution is taken, you might need to complete a self-assessment tax return to ensure you receive the full tax relief to which you are entitled. Check with your employer or pension provider, particularly if you are a higher or additional-rate taxpayer.

If you forgot to claim this extra tax relief in the past, don't worry – you can claim relief for the previous three tax years. You might find the Which? tax calculator helpful in filling out your tax return and claiming back your pension tax relief.

Can I use EIS tax relief offset my Income Tax?

Income Tax relief is available at 30% of the amount you have invested in EIS-eligible opportunities (a maximum of £1m per year, or £2m per year if backing knowledge-intensive businesses). Gains on disposal are exempt from Capital Gains Tax, the shares are exempt from Inheritance Tax and if you do make a loss, the loss can be set against your Income Tax or Capital Gains Tax. You can only claim relief against the level of Income Tax you need to pay in the UK.

You can claim Income Tax relief in the year you made the investment, or the previous year. This means that if you have a tax liability for the 2017/18 tax year, you can mitigate it by making an EIS investment in the current tax year and carrying it back; hence this is generally referred to as ‘carry back'. You cannot carry forward unused Income Tax relief.

When researching ways to offset your Income Tax, you might also want to read up on the Seed Enterprise Investment Scheme, or SEIS. This is very similar to the EIS, but aimed at younger, smaller companies. Since such companies are considered to be even more risky, the Income Tax relief on offer comes in at a generous 50%, regardless of your own top tax rate.

If you're inclined towards the idea of social impact investing, you'd do well to read up on Social Investment Tax Relief (SITR). Modelled on the EIS, SITR allows individual investors to benefit from a 30% tax relief on loan or equity investments they contribute to eligible social enterprises and charities.

Tax relief overview

Scheme Maximum annual investment
you can claim relief on
Percentage of investment
on which you can claim
EIS £1 million 30%
SEIS £100,000 50%
SITR £1 million 30%

How much pension tax relief can I claim in 2018/19?

The pensions annual allowance for the 2018/19 tax year is capped at £40,000. This means that any pension payments you make over the £40,000 limit are subject to Income Tax at the highest rate you pay.

If you have unused annual allowance from the previous three years, you may be able to carry this forward providing that you were a member of a pension scheme for the duration of those years.

What if I don't pay Income Tax?

Even if you don't pay Income Tax, you will still automatically get tax relief at a rate of 20% on the first £2,880 you pay into your pension every tax year, providing your pension provider claims tax relief for you at a rate of 20% (i.e. relief at source).

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