How Does Tax Relief Work on Workplace Pensions?

Pension contributions are calculated based on each employees qualifying earnings, not their gross pay. Find out what the qualifying earnings thresholds are, how the calculation is made and how tax relief works on workplace pensions.

1. What are Qualifying Earnings?

Qualifying earnings is the amount of gross pay used when it comes to calculating pension contributions for employees on PAYE. The government sets out an upper and lower limit to use, the current thresholds for 2021/2022 are:

2. How to Calculate Qualifying Earnings for Pensions

Qualifying Earnings 2021/2022Annual ThresholdsMonthly Thresholds
Lower Earnings Limit£6,240£520
Upper Earnings Limit£50,000£4,167

3. Calculating Tax Relief on Workplace Pensions

There are two ways to calculate tax relief on pensions when running payroll – relief at source or net pay arrangement. It’s the employers choice which one they use but the first one results in tax relief being added to your pension pot and the other results in you getting full tax relief straight away.

3.1 Relief at Source Arrangement

Under relief at source basic rate tax relief (20%) is added to employees pension pots by the pension providers.

Gross monthly salary£3,000
Qualifying earnings£3,000
Qualifying earnings for pension (£3,000 – £520)£2,480
Pension contribution (employee 5%)£124.00
Tax relief at 20% claimed by Pension Provider (£124 x 20%)£24.80
Pension Deduction (£124.00 – £24.80)£99.20

The relief at source arrangement normally benefits employees who do not pay tax on their earnings. But because the pension provider claims tax relief, they only claim this at the standard basic rate of 20% so higher rate taxpayers will need to fill in a tax return or contact HMRC to get their additional tax relief.

3.2 Net Pay Arrangement

Under the net pay arrangement employers calculate qualifying earnings for pensions in the same way as the relief at source method, but employees tax is calculated based on gross pay less pension contribution.

Gross monthly salary£3,000
Qualifying earnings£3,000
Qualifying earnings for pension (£3,000 – £520)£2,480
Pension contribution (employee 5%)£124.00

With the net pay arrangement, employees benefit from tax relief straight away and don’t need to apply for any additional tax relief if they are higher rate taxpayers because the deduction is made from gross pay and then tax is calculated.

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of www.goselfemployed.co - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.