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I have been reading about the UK workplace pensions schemes but I don't understand them very well.

What I have read is that you can choose an amount of money, which is taken from your gross salary, and it's put inside the pensions scheme. In addition, you are supposed to get a tax relief on this money, and your employer also puts money to do the 'matching contribution'.

These two last things are those that I don't understand very well.

1 - Your employer contributes with some money as well, but where does this money come from? Is it taken from your salary? If not, being in a workplace pension scheme means effectively earn more money, doesn't it? This sounds impossible to me, there must be something I'm not getting. That would mean that if you reject the pension scheme, you are effectively reducing your own salary. This sounds crazy. If this is the case, can you (legally) ask your employer for the 'matching controbution' to be added to your salary?

2 - With regards to the tax relief, it's true that your contribution is taken before paying the income tax. But, when you take your money back, do you need to pay income tax again? I see this would be beneficial if you avoid a high income tax rate and end up paying a lower one, but this still would be tax deferral, not relief, right?

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If it's a traditional pension scheme, then the money you pay in is automatically deducted from your salary every month. Most employees in the UK are on PAYE (Pay As You Earn), where the employer also takes the tax out of your pay on behalf of the tax man. If so, then when calculating your income tax, the money you pay into your pension is not counted as taxable income. So the tax doesn't actually need to be claimed back - it was never taken in the first place.

Your employer's contribution is paid by your employer out of the company's own funds. For you, it's free money. That's why it is rarely a good idea to turn down an employer's pension scheme. They now have to pay some contribution by law. But many companies pay more than the legal minimum. It's a perk that attracts employees.


Some companies offer a "salary sacrifice" pension scheme. This is a bit more complicated, but it's a trick to reduce the tax bill. You sign a form agreeing to take a pay cut. In return, your employer agrees to make all the payments into your pension out of the company's funds.

The effect on your take-home pay and on income tax remains much the same. But your employer has to pay employer's National Insurance based on your salary. By taking a pay cut, your employer pays less NI. Most employers will split their gain between themselves and the employees.


All the money you pay into an approved pension scheme is free of income tax. If you're on PAYE, then you never pay the tax on pension contributions. For personal pensions, your pension company can claim back the tax you paid, and add it to your pension fund.

When you retire and take your pension, it is counted as taxable income. Because of the way tax is tiered, if you take your pension at a sensible rate, you will probably end up paying less tax than if you'd just kept the money and put it into some kind of investment account. If you're worried about minimising your overall tax, you need to speak to a financial adviser, as it can get complicated.

In particular, taking a lump sum out of your pension fund, beyond the 25% you're allowed to have, can leave you paying a huge tax bill.

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  • you say "All the money you pay into an approved pension scheme is free of income tax. If you're on PAYE, then you never pay the tax on pension contributions [...]" and then "When you retire and take your pension, it is counted as taxable income [...]" then you do pay taxes on that pension contribution in the end, right?
    – Martel
    Nov 13 '21 at 15:28
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    @Martel It's more complicated than that. When you're employed, you pay tax based on your salary. When you retire, you pay tax based on your income as a pensioner. Most people have less income after they retire than when they were employed. Since tax is graduated, with different bands based on your income, it's likely that you will be paying less tax on your pension money than you were paying as an employee. That might even be no tax at all if your pension income is below your personal allowance.
    – Simon B
    Nov 13 '21 at 15:40

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