When you put money into your pension, the government helps by adding a tax bonus called pension tax relief. You can usually see this bonus when you log in to your pension account (if you haven’t done this before, ask your employer for your login details). This bonus depends on your marginal tax rate.
What is your marginal tax rate?
Your marginal tax rate is the rate of tax that applies to the very top layer of your income. You can think of your income like a layered Christmas cake, where each layer is taxed differently.
- Income layer 1: A fruity sponge
A fruity sponge is delicious, and so is income layer 1! That’s because the first £12,570 of your income isn’t taxed at all. This is called your personal allowance. - Income layer 2: Marzipan
Next comes a basic layer of marzipan (it’s just sugar and ground almonds!), and a basic rate of tax. In this layer, earnings between £12,571 and £50,270 are taxed at 20%. - Income layer 3: Royal icing
Royal icing is rich and so is this income layer. Earnings between £50,271 and £125,140 are taxed at 40%, known as the higher rate. - Income layer 4: Additional decorations
Additional decorations are rarer, just like the additional rate of 45%, which only applies to earnings above £125,140.
In summary:
| Tax band | Income range | Tax rate |
|---|---|---|
| Personal allowance | Up to £12,570 | 0% tax |
| Basic tax rate | £12,571 to £50,270 | 20% tax |
| Higher tax rate | £50,271 to £125,140 | 40% tax |
| Additional tax rate | Above £125,140 | 45% tax |
How does your marginal tax rate affect pension tax relief?
The government gives you pension tax relief at your marginal tax rate. That means:
- If your income is within the basic rate band, you get 20% tax relief
- If your income pushes you into the higher rate band, you get 40% tax relief
- If you’re in the additional rate band, you get 45% tax relief
Key takeaways
Your marginal tax rate is:
- The rate of tax that applies to the top layer of your income
- Used to calculate pension tax relief
- Different depending on your salary
- The reason pension contributions feel “cheaper” the higher your income
Knowing your marginal tax rate helps you make smarter decisions about saving for retirement and getting the most out of your pension.
