The mechanics of reclaiming higher rate tax

Oompa_Lumpa

In preparation for the forthcoming end of the tax year I thought I would see what my year end position is likely to be.

Total salary & BIK £43,350

Pension deductions from net pay £2595

So if I gross up my pension payments by 100/78 then the amount of my pension contributions is £3327.

That leaves my "taxable" income as £40,023 (43350-3327) , with the 40% band starting at £38,335.


So my questions are:
If I don't do anything different to the above scenario will I receive a cheque for (£3327*18%) = £598.86, being the extra 18% on all my pension contributions?


Now we are getting into the more subjective part of my post:

I won't be a higher rate tax payer in my retirement, therefore if I can afford to pay additional contributions this year then I should do so insofar as they will take my "taxable" income down to the 40% band - right?

Let's say I do that.

Would the following be correct:

I make additional pension contributions of £1688 (this takes me down to £38,335).

Will the cheque that I get back from HMRC now be (£598.86 from above + £1688*40%) = £1274.06?

So in that case I contribute an additional one off amount of £1688, and then in a few months time I will receive a cheque for £1274.

I appreciate that posting figures may be considered "vulgar" but it is easier when dealing with real numbers than having hypothetical discussions.


Is my understanding of the above correct? This year is the first that I am a higher rate tax payer and I am not sure of the mechanics of the tax relief.

Thanks in advance.

Paul_Herring

Oompa_Lumpa wrote:

In preparation for the forthcoming end of the tax year I thought I would see what my year end position is likely to be.

Total salary & BIK £43,350

Pension deductions from net pay £2595

So if I gross up my pension payments by 100/78 then the amount of my pension contributions is £3327.

That leaves my "taxable" income as £40,023 (43350-3327) , with the 40% band starting at £38,335.

Correct so far.

So my questions are:
If I don't do anything different to the above scenario will I receive a cheque for (£3327*18%) = £598.86, being the extra 18% on all my pension contributions?

Regarding the cheque, do you fill out any form of self assesment? If so, probably - assuming other income - intrest from banks etc doesn't wipe it out. You can also have it paid direct into your bank account.

If you don't have any form of SA, I'm not sure.

Now we are getting into the more subjective part of my post:

I won't be a higher rate tax payer in my retirement, therefore if I can afford to pay additional contributions this year then I should do so insofar as they will take my "taxable" income down to the 40% band - right?

The theory is, that pensions are merely tax deferment, in that most people will be in the same tax band before and after retirement (i.e. if you're in the 22% before, you're more than likely to be in the 22% after. Conversely, if you're 40% before, you're likely to be in the 40% after) thus the only benefit is the tax relief on the 25% tax free you can (currently!) withdraw at retirement age.

If, however, you work things out so that before retirement, you 'convert from a higher rate tax payer into a lower rate tax payer' by contributing enough from your salary to take your marginal rate to 22%, you will get 18% of the difference between your real (net) salary and your salary after contributions rebated at the end of every tax year. If you can keep your post-retirement income in the 22% band, you keep this permanantly. This is usually worth doing. This also assumes that income tax positions remain largely the same when you retire.

Let's say I do that.

Would the following be correct:

I make additional pension contributions of £1688 (this takes me down to £38,335).

Will the cheque that I get back from HMRC now be (£598.86 from above + £1688*40%) = £1274.06?

No. 22% is claimed back by your pension company - you only get the extra 18% on any extra contributions.

I appreciate that posting figures may be considered "vulgar" but it is easier when dealing with real numbers than having hypothetical discussions.

it's the only way you'll get real answers.

Oompa_Lumpa

Paul, thanks for your help.

Paul_Herring wrote:

Regarding the cheque, do you fill out any form of self assesment? If so, probably - assuming other income - intrest from banks etc doesn't wipe it out. You can also have it paid direct into your bank account.

If you don't have any form of SA, I'm not sure.

I will be completing a SA for this year (ie the year we are discussing).

Paul_Herring wrote:

No. 22% is claimed back by your pension company - you only get the extra 18% on any extra contributions.

OK, that amounts to the same thing. As using your example I would only pay 22% in the first place.
I assumed as I would write a one off cheque that I would remit the entire payment, and not the 78/100 as you seem to be suggesting.
Either way I'll end up the same way financially.


One other question, should I write the one off cheque this side of April 5th? I know in the long term it won't matter post A-Day, but on the practicalities of recovering the tax and for this year's SA should I pay it this fiscal year, or does it not really matter?


In conclusion based on my numbers (where you are just a few k above the higher rate threshold, and not far enough ahead of it to think that you will be a higher rate payer in retirement) it appears to make sense to pay a little extra as pension contributions (providing you can afford it) as those marginal contributions are pretty cheap.

Paul_Herring

OK, that amounts to the same thing. As using your example I would only pay 22% in the first place.
I assumed as I would write a one off cheque that I would remit the entire payment, and not the 78/100 as you seem to be suggesting.
Either way I'll end up the same way financially.

You're submitting a cheque from your post tax income. You get the 40% tax refunded (22% directly into your pension, 18% as a rebate from your SA.)

One other question, should I write the one off cheque this side of April 5th? I know in the long term it won't matter post A-Day, but on the practicalities of recovering the tax and for this year's SA should I pay it this fiscal year, or does it not really matter?

Practically, as far as your pension is concerned it doesn't matter when.
However, as far as your tax payments are concerned I'd do it this tax year to get this years' gross pay to the lower marginal rate band. And I'd do it well before April 5th.

In conclusion based on my numbers (where you are just a few k above the higher rate threshold, and not far enough ahead of it to think that you will be a higher rate payer in retirement) it appears to make sense to pay a little extra as pension contributions (providing you can afford it) as those marginal contributions are pretty cheap.

They are. However, don't forget any other income you have coming in (usually interest from banks/savings, unusally - any rent from BTL's, shares etc.) as this may well take you back over the 40% barrier.

Oompa_Lumpa

Thanks again Paul (I can't get the thanks button to work).

Are you allowed to actively contribute to more than 1 pension scheme?

My works pension scheme is pretty poor, and I would rather not put any additional contributions into that scheme if at all possible.

So could I open another pension scheme in which to place this (and any further year's additional) contributions?

Paul_Herring

Are you allowed to actively contribute to more than 1 pension scheme?

My works pension scheme is pretty poor, and I would rather not put any additional contributions into that scheme if at all possible.

So could I open another pension scheme in which to place this (and any further year's additional) contributions?

I think we need details of your pension scheme - I'm assuming it's defined contribution (as opposed to defined benefit.)

Who runs it? What are your funds invested in at the moment? Why do you say your company's scheme is 'pretty poor?'

(The likely answer is yes you could open another scheme and contribute to that, but another likely answer is to improve the scheme you already have by talking to the provider.)

jem16

Oompa_Lumpa wrote:

In conclusion based on my numbers (where you are just a few k above the higher rate threshold, and not far enough ahead of it to think that you will be a higher rate payer in retirement) it appears to make sense to pay a little extra as pension contributions (providing you can afford it) as those marginal contributions are pretty cheap.

This is exactly what I'm planning to do too. I'm around £3500 into the HRT bracket but will be a basic rate taxpayer on retirement. Putting this into a pension will save me around £700 tax each year.