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Better than 40% tax relief

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If you are a higher rate tax payer (on some of your pay, however small) and you make sufficient pension contributions (in excess of that part of your pay that is subject to HRT) so that you pay in some of the interest earned from savings and/or dividend interest, you get more than 40% tax relief.

This is because the effect of a pension contribution is to lift the upper limit of your basic rate band. You get what is known as an enhanced basic rate band.

Here is how it works:
  • If you make pension contributions from your savings interest, the adjustment to your basic rate band means you pay tax on this at 20% instead of at 40% (a saving of 20%). Your tax relief is the 22% (you receive automatically) plus 20% (you get by applying to the tax office) = 42%.
  • If you make pension contributions from your dividend income, the adjustment to your basic rate band means you pay tax on this at 10% instead of at 32.5% (a saving of 22.5%). Your tax relief is the 22% (you receive automatically) plus 22.5% (you get by applying to the tax office) = 44.5%.
So you get between 40% and 44.5% tax relief depending on the mix of earned, savings and dividend income you pay to your pension.

Your contributions need to exceed the earned income you would pay HRT tax on if you didn't make any contribution.
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Comments

  • Innys
    Innys Posts: 1,881 Forumite
    I'm sorry, but I don't understand this at all.

    Can you please quote some sample figures (salary, interest, pensions contributions) and associated calculations to show what you mean?

    Thanks

    A
  • noh
    noh Posts: 5,817 Forumite
    Part of the Furniture 1,000 Posts Name Dropper
    Innys wrote: »
    I'm sorry, but I don't understand this at all.

    Can you please quote some sample figures (salary, interest, pensions contributions) and associated calculations to show what you mean?

    Thanks

    A

    Thats because its incorrect! HMRC rebate 18% of the grossed up contribution to higher rate tax payers whatever the source of the original contribution.
    ie a higer rate tax payer pays a contribution of £780 22% tax relief is claimed by the pension provider so total gross contribution is £1000. The tax payer is given a tax rebate from HMRC of £180 total net cost to tax payer £600. So for a net cost of £600 the higher rate tax payer gets £1000 benefit which is a rate of relief of 40%


    Nigel
  • Innys
    Innys Posts: 1,881 Forumite
    Nigel

    That's how I thought it worked as well.

    Say your monthly salary is £10k (I wish) and you pay £1k of it into your pension. You get taxed at 40% on the balance of £9k it giving you a net take home of £5,400. The £1k is also taxed at 22% but the pension provider claims back the 22% from Gordon's gophers, taking it back to the full £1k.

    If you had not paid anything to your pension you would have got 60% of £10k, £6k. By opting to pay money into your pension you have received £5.4k + £1k - a net gain of £400, though admittedly it is in your pension fund, not your pocket.

    I don't see how savings interest would fit into this calculation at all.

    I
  • Dithering_Dad
    Dithering_Dad Posts: 4,554 Forumite
    Mortgage-free Glee!
    Sorry, but it's not incorrect. It only works though if you earn more in dividends over the HRT than you take in pension contributions... If you are a company director who gets most of his income from dividends (i.e. an I.T. contractor like yours truly), you can get 44.5% tax relief. Here is a tax example as provided by a contractor website:

    Dividend Payments
    It is not uncommon for a controlling director to have a remuneration package that consists heavily of dividend payments. Dividend payments are distributed from the net profits of a limited company and are paid net of a 10% tax credit. If the shareholder is not a higher rate taxpayer after taking into account the gross dividend, then no further tax is due. If any part of the gross dividend falls within the higher rate tax band then income tax is levied at the rate of 22.5% on that part of the gross dividend. Making a pension contribution that increases the basic rate tax band will remove the additional tax liability on any dividend payment that would fall within the increase to the basic rate tax band. In the following example the client earns £10,000 and receives dividend payments of £40,000:-

    Gross Income: £54,444.44 [£10,000 + (£40,000/0.90)]
    Pension Contribution: £7,800


    BAND
    TAX
    Personal Allowance....£5035..........£0
    Lower Rate (10%).....£2150.00......£215.00
    Basic Rate (22%)......£2815.00......£619.30
    Higher Rate(22.5%)...£6109..........£1374.52
    TOTAL TAX................................£2208.82

    The effective rate of tax relief on the contribution is 44.5%. This is calculated by adding the basic rate tax credit of £2,200 to the saving in income tax £2,250 (£4,458.92 - £2,208.92) and dividing by the gross contribution of £10,000.
    Mortgage Free in 3 Years (Apr 2007 / Currently / Δ Difference)
    [strike]● Interest Only Pt: £36,924.12 / £ - - - - 1.00 / Δ £36,923.12[/strike] - Paid off! Yay!! :)
    ● Home Extension: £48,468.07 / £44,435.42 / Δ £4032.65
    ● Repayment Part: £64,331.11 / £59,877.15 / Δ £4453.96
    Total Mortgage Debt: £149,723.30 / £104,313.57 / Δ £45,409.73
  • dunstonh
    dunstonh Posts: 119,685 Forumite
    Part of the Furniture 10,000 Posts Name Dropper Combo Breaker
    You can get upto around 70% effective relief as well if the you would qualify for working/childrens tax credits because of the reduction in your income due to pension contributions.
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • Dithering_Dad
    Dithering_Dad Posts: 4,554 Forumite
    Mortgage-free Glee!
    That was something I was considering doing once my mortgage is paid off and my outgoing were down significantly enough to afford to do it:

    I could earn £100k through my company, pay myself 11k per year, which after tax and NI would be about £8900, which would allow me to claim WTC and CTC (and with the Child Benefit I already receive), I'd get an additional £11k per year of tax payers money, so my income would be £19,900 and I could pay £89,000 into my pension plan. Don't you love the labour government for it's daft tax credits that encourage us to earn less!! :)
    Mortgage Free in 3 Years (Apr 2007 / Currently / Δ Difference)
    [strike]● Interest Only Pt: £36,924.12 / £ - - - - 1.00 / Δ £36,923.12[/strike] - Paid off! Yay!! :)
    ● Home Extension: £48,468.07 / £44,435.42 / Δ £4032.65
    ● Repayment Part: £64,331.11 / £59,877.15 / Δ £4453.96
    Total Mortgage Debt: £149,723.30 / £104,313.57 / Δ £45,409.73
  • noh
    noh Posts: 5,817 Forumite
    Part of the Furniture 1,000 Posts Name Dropper
    Sorry, but it's not incorrect. It only works though if you earn more in dividends over the HRT than you take in pension contributions... If you are a company director who gets most of his income from dividends (i.e. an I.T. contractor like yours truly), you can get 44.5% tax relief. Here is a tax example as provided by a contractor website:

    .

    Yes I see that now it, as you say, it only works for that amount of dividend income you shift into the basic rate band. You save 22.5% tax on that portion plus the 22% rebate to the pension provider total 44.5%.
    It would also work for any savings income shifted into the basic rate band 20% tax saved + 22% rebate =42%. Of course next year when basic rates become 20% there will be less of an advantage.

    Nigel
  • david78
    david78 Posts: 1,654 Forumite
    My original post is certainly correct.

    There is only a benefit if your contributions exceed the amount of your earnings on which you pay 40% tax and you have some savings interest and/or dividend income. The benefit may be small.

    I am thinking about changing the way I pay into my pension to take advantage of this. Suppose I have pay of £1000 on which I pay 40% tax and I put £1000 gross (£780 net) into a pension plan to get 40% relief.

    Well, if I also get £1000 in dividend income each year I might be better off paying £2000 gross every other year instead. (there is the question of £1000 not being invested in alternate years, but this could be invested outside of a pension wrapper if need be)

    I have built a simple excel spreadsheet to calculate the benefits (it will also calculate your tax). I can post it here, when I find out how?
  • david78
    david78 Posts: 1,654 Forumite
    dunstonh wrote: »
    You can get upto around 70% effective relief as well if the you would qualify for working/childrens tax credits because of the reduction in your income due to pension contributions.

    Thanks, I was aware of this too.
  • noh
    noh Posts: 5,817 Forumite
    Part of the Furniture 1,000 Posts Name Dropper
    david78 wrote: »
    My original post is certainly correct.

    There is only a benefit if your contributions exceed the amount of your earnings on which you pay 40% tax and you have some savings interest and/or dividend income. The benefit may be small.

    I am thinking about changing the way I pay into my pension to take advantage of this. Suppose I have pay of £1000 on which I pay 40% tax and I put £1000 gross (£780 net) into a pension plan to get 40% relief.

    Well, if I also get £1000 in dividend income each year I might be better off paying £2000 gross every other year instead. (there is the question of £1000 not being invested in alternate years, but this could be invested outside of a pension wrapper if need be)

    I have built a simple excel spreadsheet to calculate the benefits (it will also calculate your tax). I can post it here, when I find out how?

    Basic rate tax reduces to 20% next year and the 10% band is removed except for savings income. This will reduce the effective relief to 40% for savings income and 42.5% for dividend income assuming the higher rate tax on dividends remains the same.

    Nigel
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