Pension Contributions for Higher Rate Tax payers

clark955

I was wondering if anyone can help me.
I'm think of paying money into a Personal Pension. All the web sites I've seen tell me that for every 78p i put into a pension the revenue put in 22p, this being the rate for a basic tax payer 22%. The other 18% I'm meant to reclaim back from the revenue.

Any way I've been looking at how the tax return calculations work to reclaim this and I'm confused. They seem to add the gross amount paid into a pension to the 22% tax band and reduce the 40% tax band accordingly and then refund.

e.g.
lets suppose I contribute £780 p.a. to my pension, and the IR contribute £220. Making a £1000 gross.
The IR add this to the 22% tax band allowance so for 2005/6 the alowance of £32400 becomes £33400 (£32400+1000)
They then refund 18% of the £1000 I originally paid 40% on which equals £180.
Great, but this is where I'm confused!!!
In order to pay in the orignal £780 pounds I would have to have earnt 780/60*100 as a higher rate tax payer = £1300.
But the IR have only given me £220 into my pension + £180 rebate which makes £780+£220+£180= £1180 - a shortfall of £120.

Is all of this correct? The error seems to appear because they only pay 22p for every 78p into my pension fund and not for every 60p

Any guidance would be greatly appreciated.

Graham

dunstonh

You pay £100 into a pension and the direct debit is £78. The other £18 is deducted from the tax you owe after declaring it on your tax return. Often the revenue will increase the tax code to take the pension contributions into account if they are regular.

The way the revenue calculate it is to stop people getting 40% on the whole contribution if they were just a bit over. It makes sure that you arent getting 40% tax relief on the whole contribution if you are not entitled to it. For example, If you are £10 in to higher rate tax, you cannot get 40% relief on the whole of your pension contribution. Just the amount you are into the higher rate.

clark955

Thanks for the reply and yes I believe I understand that.

However, I still think I will not get the full relief available for any amount I actually have paid 40% tax on. I've run various scenarios through some tax programs and it appears that for each £1 gross pay at a tax rate of 40% leaving me with a net of 60p the IR will put back into my pension 22p for each 78p e.g. 60/78*22= 16.9p and refund me 18p. Which means I have 60p+16.9p = 76.9p in my pension pot and a refund of 18p from the tax man, making 94.9p leaving me 5.1p (5.1%) short of the original gross £1 I started with.

So I'm still confused!

Graham

bootman

I too am confused about this. My husband used to have the £78 lets say for easy maths deducted from his pay and it was sent to his pension pot. He paid no tax on his payslip for this amount so when the p60 arrived it aleady showed no tax paid on the 12x £78 made = £936 so if the total gross pay for the year was say £100,936 he had only paid tax on the £100,000. (made up figure by the way)

When he did his tax return his P60 figure was £936 less than his total gross earnings.

He then entered the grossed up figure on the tax return of £1200.

This made sense.

He now works for another company but kept the same pension running it was one of those you could carry on if you left. We now pay to it ourselves.

So now he is taxed on all of his pay, but we still make the £78 payment to the pension each month by d/d from our bank account.

So are we worse off ?? the tax return figures are still £1200 but he is paying tax on all his pay now even though some of it is going to the same pension. No longer is there a difference of the £936 tax free on the payslip.

I look at it as being taxed twice, or am I wrong. I just can't fatham it out. Please help if you understand it. Should I be knocking off the £936 from the P60 figure?

dunstonh

When you pay via your payslip, the pension is taken off the gross income before tax is paid on it. Therefore the contribution gets tax relief at the point. With a direct debit, its only possible to get basic rate relief on it with the remainder being done on the tax return.

Should I be knocking off the £936 from the P60 figure?

No. You should declare full income and declare the gross pension contribution in the pension section.

However, I still think I will not get the full relief available for any amount I actually have paid 40% tax on. I've run various scenarios through some tax programs and it appears that for each £1 gross pay at a tax rate of 40% leaving me with a net of 60p the IR will put back into my pension 22p for each 78p e.g. 60/78*22= 16.9p and refund me 18p. Which means I have 60p+16.9p = 76.9p in my pension pot and a refund of 18p from the tax man, making 94.9p leaving me 5.1p (5.1%) short of the original gross £1 I started with.

The 18% is on the gross contribution and not the net contribution. I cannot replicate your error on my software which does have a tax calculator and that is coming out as expected. The error is in your calculations which I cannot quite work out why you are doing it that way.

taylornj

Yes looks like your confused. For each £100 in pension pot = £60 + £18 + £22.
£60 = what you paid in
£22 = what HMRC refunded to the pension.
£18 = what you paid in but refunded by HMRC to you.

£100 gross pay you receive £60 net, you pay £60 and borrow £18 to pay £78 into pension, HMRC add £22 making £100 in your pension pot. Then HMRC pay you back the £18 you borrowed when you submit your return.

Don't try to think your earning £78 if you do. Try it this way you earn £130 gross, and receive £78 net pay, you pay £78 into pension, and pension receives £22 from HMRC making £100 in your pension pot. You receive back £18 from the HMRC which is 18/60% = £30 gross. So in effect you paid £100 gross into you pension, and received £30 gross pay. Your always having to find the extra £18 until the HMRC refunds it.


This is still wrong, because for £100 gross you don't get £60 but £59 or £49 because of the employee's National Insurance. Some of that £11 National Insurance goes towards S2P a pension pot of sorts. Which is why it's better to reduce your gross salary and have your employer pay direct into the pension plan the gross amount - when the employer says this is extra work remind him he's paying £12.8 Employer's National Insurance on every £100 gross pay you receive, and up to a certain level some of the £12.8 is also going towards S2P (not much). If your employer is very good for every £100 it would cost them very little to add upto £12.8 the Employer's National Insurance they would have had to pay if you took salary rather than pension.

The most effecient way of putting contributions into a pension is for the employer to pay gross into a pension pot, more so for basic rate tax payers who are nearly always in the 11% Employee's NI band.

Most employers will be paying a gross amount into a pension plan.

bootman wrote:

When he did his tax return his P60 figure was £936 less than his total gross earnings.

He then entered the grossed up figure on the tax return of £1200.

This is wrong if the employer paid into a pension it is most liekly a gross (pretax) payment so the gross amount would be £936. To get the same amount into a pension from net paid you need to multiple the £78 by .78.

Redoing the example £101,200 gross package, elected to pay £1,200 gross pa into pension £100/month making gross salary £100,000 as per P60, and total gross pension contributions of £1200 - no tax needs to be reclaimed, and nothing needs to be put on the tax return for pensions (have to double check).

Now new employers pay £101,200 gross salary, you pay £78 / month into pension but receive only £60 extra in net pay (really £59 counting NI), the £18 difference is made up when tax return reclaims the 12 x £18 for each tax year by entering £1200 gross for pension. In all you are £12 worse off due to NI, and employers are £153.6 worse off due to NI.

clark955

Thanks to all those who responded. I finally understand.

bootman

My head is spinning! I will keep re- reading to try and understand.

Many thanks everyone for your time.