Saving tax through pension contributions is one of the most effective ways to reduce your tax bill while building a retirement fund. In this section, we’ll walk through three practical examples that show exactly how much tax you can save depending on your situation: as an employee, a self-employed individual, and a company director receiving contributions from your own limited company.
Tax Savings for an Employee in a Workplace Pension
Scenario:
Sarah is employed, earns £45,000 a year, and contributes 5% of her salary to her workplace pension. Her employer also contributes 3%.
- Salary: £45,000
- Sarah's contribution (5%): £2,250
- Employer's contribution (3%): £1,350
- Tax relief method: Salary Sacrifice or via payroll before tax
Sarah’s contributions are deducted before income tax is calculated, meaning her taxable income is reduced. Without pension contributions, Sarah would pay tax on the full £45,000. But by contributing £2,250, she only pays tax on £42,750.
Tax savings breakdown:
-
Income tax before pension contribution (for England, 2023/24 rates):
- Personal allowance (0% on £12,570): £0
- Basic rate (20% on £37,700): £7,460
- Higher rate (40% on £2,300): £920
Total tax before contributions: £8,380
-
Income tax after pension contribution (taxable income now £42,750):
- Personal allowance (0% on £12,570): £0
- Basic rate (20% on £30,180): £6,036
- Higher rate (40% on £0): £0
Total tax after contributions: £6,036
Tax saved:
£8,380 (before contributions) – £6,036 (after contributions) = £2,344 saved in tax.
Additionally, Sarah’s employer adds £1,350 to her pension without affecting her tax bill, making her total pension pot contribution for the year £3,600, while only £2,250 came out of her salary.
Tax Savings for a Self-Employed Person Contributing to a Personal Pension
Scenario:
John is self-employed and earns £70,000 a year. He decides to contribute £10,000 to a personal pension (Self-Invested Personal Pension, SIPP).
- Income: £70,000
- John's contribution: £10,000
- Tax relief method: Relief at source (HMRC adds 20% automatically, John claims higher-rate relief via Self-Assessment).
John pays 40% tax on income over £50,270, so part of his pension contribution attracts higher-rate tax relief.
Tax savings breakdown:
-
Pension contribution:
John contributes £8,000 net, and HMRC adds £2,000 in basic-rate relief (20%), making the total pension contribution £10,000. -
Higher-rate tax relief:
John earns £70,000, which means he pays 40% tax on the £19,730 that exceeds the higher-rate threshold (£50,270). He can claim an additional 20% (the difference between the 40% tax rate and the 20% basic rate) on this portion.
- John’s additional tax relief is 20% on £10,000 (the gross pension contribution), so he claims back an extra £2,000 through his tax return.
Total tax saved:
John contributes £10,000 to his pension but effectively only pays £6,000 out of pocket (£8,000 net contribution minus £2,000 extra relief claimed).
John has saved £4,000 in tax overall (£2,000 basic-rate relief + £2,000 higher-rate relief).
Tax Savings for a Company Director with Employer Pension Contributions
Scenario:
Sophie is a director of her own limited company and draws a salary of £50,000. Her company decides to make a £30,000 pension contribution on her behalf. The contribution is treated as a business expense, reducing the company's Corporation Tax bill.
- Salary: £50,000
- Company pension contribution: £30,000
- Tax relief method: Corporation Tax relief
How tax is saved:
-
Company savings:
The £30,000 pension contribution reduces the company’s taxable profits, which in turn reduces its Corporation Tax liability. Corporation Tax in 2023/24 is 19%, so the company saves 19% of £30,000 = £5,700 in Corporation Tax. -
Sophie’s personal savings:
Sophie doesn’t pay any income tax or National Insurance on the pension contribution because it’s made directly by her company. Had Sophie drawn the £30,000 as salary instead, she would have paid 40% income tax on most of it (as it pushes her into the higher-rate tax band) plus National Insurance at 2%.
If she had taken the £30,000 as salary, she would have paid:
- 40% income tax on £29,730 (after basic-rate threshold): £11,892
- 2% National Insurance on £29,730: £595
- Total tax and NI: £12,487.
By opting for a pension contribution, Sophie avoids paying £12,487 in tax and National Insurance, in addition to the company’s £5,700 Corporation Tax saving.
Total tax saved:
- Sophie: £12,487 in income tax and National Insurance
- Company: £5,700 in Corporation Tax
Combined tax saving: £18,187.
Conclusion: Practical Tax Savings from Pension Contributions
- Employees: Reduce taxable income and lower your income tax bill. Sarah saved £2,344 in tax through her workplace pension contributions.
- Self-employed individuals: Claim tax relief on personal pension contributions. John saved £4,000 in tax by contributing to his SIPP.
- Company directors: Maximise tax savings by having your company contribute to your pension. Sophie saved £18,187 in combined personal and company tax savings.
Pension contributions are a key tool for reducing taxes and saving for retirement, with clear benefits whether you are employed, self-employed, or a company director.
For more detailed advice, always consult a tax professional or financial advisor to ensure you maximise your pension contributions and tax savings.