One of the major benefits of paying into a pension is receiving tax relief on your contributions.
However, if you receive rental income from a buy to let property, you cannot pay this money into your pension and receive tax relief on it. Given that pension tax relief can give your pension a valuable boost, it’s vital to understand how different income sources affect your eligibility to it, so you don’t fall foul of the rules. You can read more about tax relief in our guide How pension tax relief works.
Here, we explain how property income affects your eligibility to pension tax relief, and which income sources you can receive relief on.
If you’re considering getting professional financial advice, Unbiased is offering Rest Less members a free pension review. It’s a chance to have a qualified independent financial advisor (IFA) take a look at your pension arrangements and give an unbiased assessment of your retirement savings.
The review is free and without obligation, but if the IFA feels you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
Is property rental income eligible for pension tax relief?
Rental income from a buy to let property is not eligible for pension tax relief as it’s considered ‘unearned income’. That’s because it’s received from a passive income source (property) rather than through employment.
However, you can receive pension tax relief on any ‘relevant earnings’ you have. ‘Relevant earnings’ are the types of income considered eligible for pension relief.
They include:
- income from your employment (for example salary, wages, bonus, over time or commission)
- profit-related pay (including the part which is not taxable)
- any redundancy payment above the £30,000 tax exempt threshold
- benefits in kind which are taxable
- income from a trade or profession carried out individually or as a partner personally acting in a partnership
- rental income from furnished holiday lets (FHLs) (but NOT buy to let rental income). Bear in mind, that specific criteria is used to determine eligibility for FHL status. Find out more about this in our guide Holiday let or buy to let: which is better?
If you pay into a defined contribution pension (rather than a final salary pension) you can pay in up to 100% of your relevant earnings into your pension each tax year, up to a maximum Annual Allowance of £60,000. Read more about pension allowances in our guide How do pension allowances work?
Example 1: No earned income, only rental income
Sarah receives £40,000 per year from renting out a property, but isn’t currently working.
Since her income is solely from a buy to let property, it’s considered unearned and will not be eligible for pension tax relief. She only benefits from the personal allowance on her rental income. This enables her to earn £12,570 in the 2023/24 tax year before she starts paying tax on her income.
However, even though she is unemployed, Sarah can still contribute up to £2,880 to a pension each tax year. Provided this amount is from one of the relevant earning sources listed above and not rental income from her buy to let property, she will receive tax relief of 20% on it which tops up her contribution to £3,600 in total.
Alternatively, anyone else, for example her partner, can set up a personal defined contribution pension on her behalf such as a stakeholder or self-invested personal pension (SIPP), and pay into it for her.
You can find out more about this in our guide Can my husband or wife pay into my pension? – Rest Less
Example: Some earned income, some rental income
John, a business owner, earns £70,000 per year and receives £20,000 in rental income. John is eligible for the full Annual Allowance of £60,000 and can receive tax relief on his pension contributions up to this limit from his earned income. However, he won’t receive any tax relief on pension contributions made from his rental income.
To make a gross pension contribution of £60,000, John would only need to pay £48,000, with the Government topping this up by £12,000.
As a 40% higher rate taxpayer, John can claim back up to an extra £7,946 via his self-assessment tax return, meaning his pension contribution effectively costs him as little as £40,054.
Making pension contributions from your earned income can be a useful tax planning tool, as it decreases your taxable income. This may place you in a lower income bracket for tax purposes and reduce the amount of tax you pay. However, the same potential tax advantage doesn’t apply to pension contributions made from unearned income like rental income.
How does property income affect my Annual Allowance?
While you can’t use rental income to contribute to pension contributions (unless it’s from a holiday lettings business), it can indirectly affect your Annual Allowance. As mentioned, this is the yearly limit for pension contributions that are eligible for tax relief, and is currently £60,000. Your total income, including taxable sources like rental income, affects your tax bracket. Higher income levels may trigger what’s known as the ‘tapered allowance’ for higher earners, reducing the maximum amount eligible for tax relief.
To understand how the taper works, you first need to get to grips with the terms ‘threshold income’ and ‘adjusted income’. Threshold income relates to everything you bring in over the year, so that includes your salary, any bonus, any income from your pension or bank interest, trading profits, and your rental income. Any pension contributions you’ve made are deducted from this sum to give you your threshold income. Adjusted income, meanwhile, is your threshold income plus any pension or company pension contributions made.
The rules are complex, and it’s worth seeking advice if you’re uncertain, but essentially once your threshold income goes above £200,000, your allowance reduces by £1 for every £2 your adjusted income rises above £260,000. The minimum Annual Allowance this can taper to is £10,000.
Remember, too, that when you sell a property any profit your make could also push you into a significantly higher income bracket in a particular tax year, potentially triggering the tapered allowance and affecting your eligibility to pension tax relief.
Example: High earner with rental income
Emma, a lawyer earning £200,000, also has rental properties bringing in £70,000 a year. She will be impacted by the tapered allowance. For every £2 she makes over £260,000, her Annual Allowance (normally £60,000) shrinks by £1. In Emma’s case, her excess income is £10,000, reducing her Annual Allowance to £55,000.
So, Emma can still contribute a good chunk to her pension tax-efficiently, but not the full £60,000. However, if she has any unused pension allowance from previous years (carry forward), she can add this to the £55,000. Read more about this rule in our guide Pension carry forward explained.
To make a gross pension contribution of £55,000, Emma only needs to pay £44,000. The Government will add top this up to £11,000. As a 45% additional rate taxpayer, Emma can claim back up to an extra £13,750, so her £55,000 pension contribution will have effectively cost her £30,250.
Seek professional advice
Working out how income received from renting out property affects your eligibility to pension tax relief can be complicated.
It’s also worth remembering that pension tax rates and benefits can change and are dependent on your personal circumstances so there are no guarantees that current rules will continue to apply in future. If you’re not sure about how to maximise your pension, it can be a good idea to seek professional independent financial advice.
If you’re considering getting professional financial advice, Unbiased is offering Rest Less members a free pension review. It’s a chance to have a qualified independent financial advisor (IFA) take a look at your pension arrangements and give an unbiased assessment of your retirement savings.
The review is free and without obligation, but if the IFA feels you’d benefit from paid financial advice, they’ll go over how that works and the charges involved.
Rest Less Money is on Instagram. Check out our account and give us a follow @rest_less_uk_money for all the latest Money News, updated daily.