Tax relief on pension contributions

Mirador

If someone earns £16000 in a year, what is the optimum amount to pay into a pension fund to maximise tax relief.
Should you subtract the personal allowance first and only pay in £4000, thereby receiving £1000 tax relief, or can you pay in the whole amount and use carry forward allowance to receive tax relief on the full £16000 ?
Thank you to anyone who understands how this works!

dunroving

Mirador wrote: »

If someone earns £16000 in a year, what is the optimum amount to pay into a pension fund to maximise tax relief.
Should you subtract the personal allowance first and only pay in £4000, thereby receiving £1000 tax relief, or can you pay in the whole amount and use carry forward allowance to receive tax relief on the full £16000 ?
Thank you to anyone who understands how this works!

I'd say 100% of earnings wold maximise the tax "bump" because you get tax relief on the personal allowance amount, which you didn't actually pay tax on ... also, if the earned income is only £16,000, in most situations you wouldn't need to use carry-forward allowance.

xylophone

See https://www.gov.uk/tax-on-your-private-pension/pension-tax-relief

Try calculator here http://www.hl.co.uk/pensions/interactive-calculators/tax-relief-calculator

jamesd

If it is a personal contribution the answer is £16,000.

If it is a contribution by salary sacrifice the answer is £6,000 by salary sacrifice and an additional £10,000 personal contribution. This is because salary sacrifice only gives the tax relief at the tax rate being charge don the pay and that would be zero within the personal allowance range. Minimum wage law would normally prevent income from getting this low for full time employees but it's possible for part timers.

Carry-forward is irrelevant for this because it only applies where the annual contribution allowance of £40,000 is being exceeded and the income here isn't high enough to do that. You can't carry forward income from past years, just the allowance, and if the income is lower than the allowance, the income is the restriction.

Mirador

Can I just clarify then. If you pay in your full £16000 salary, then receive tax relief of £4000, plus employee contribution of £500, the total amount received by the pension fund would be £20,500. But wouldn't that then exceed the annual earnings allowance limit?

So should the calculation actually be :

£16000 gross earnings less £500 employer contribution = £15500

£15500 less tax relief £3100 = £12400

Therefore £12400 is the maximum salary that can be paid in?

What is the penalty if you exceed yor annual earnings allowance? Do you just have to repay the tax relief that was given, or is there an additional penalty?

So many questions, so little knowledge!

dunroving

Mirador wrote: »

Can I just clarify then. If you pay in your full £16000 salary, then receive tax relief of £4000, plus employee contribution of £500, the total amount received by the pension fund would be £20,500. But wouldn't that then exceed the annual earnings allowance limit?

So should the calculation actually be :

£16000 gross earnings less £500 employer contribution = £15500

£15500 less tax relief £3100 = £12400

Therefore £12400 is the maximum salary that can be paid in?

What is the penalty if you exceed yor annual earnings allowance? Do you just have to repay the tax relief that was given, or is there an additional penalty?

So many questions, so little knowledge!

I got confused with this issue also, just recently. Your personal contributions can be up to 100% of earnings. Other growth (employer contributions, accrual on a DC scheme) apply to the annual allowance.


So, ignoring NI and other deductions, etc., if a person earned £16,000 and has a £10,000 personal allowance their take-home pay would be £10,000 + (.80*£6,000) = £14,800.


However, if you paid into a SIPP or other pension with take-home pay you'd only need to pay in £16,000*.80 = £12,800. The SIPP provider would then get the 20% tax relief of £3,200 from HMRC to top it up to £16,000.


Essentially, paying 100% of earnings into a pension gives you a free bump from HMRC of £2,000 (for a personal allowance of £10,000). Seems too good to be true but I have been pointed to the regulations by several people on here.


Simplistic illustration but hope it conveys the basic principles.

jamesd

Yes, you really can pay in your whole earnings without worrying about the tax relief being more than the tax you pay. You're perfectly entitled to that tax relief even though no tax was ever due on the personal allowance part of the money.

Think of it as a bit like working tax credits, it's there to get you to do something socially worthwhile, even though it costs some tax money up front.