Pension contribution tax relief

Seamonster_2

I hope this question makes sense.

I understand that if you are a higher-rate (40%) taxpayer and make pension contributions by salary sacrifice, they attract 40% tax relief. My question is: Does this rate apply to all your contributions, regardless of how high they are? For example – keeping the figures simple – say your taxable salary after deduction of personal allowance is £32,865. This is £1000 above the £31,865 upper limit of the 20% tax band. You pay £1000 p/a in employee pension contributions, which attract 40% tax relief. If you then increase your contributions by a further £500 p/a, this would come out of the portion of your salary taxed at 20%, so do you only get 20% tax relief on this new pension contribution? Or does it stay at 40% for the whole £1500?

dunroving

Seamonster wrote: »

I hope this question makes sense.

I understand that if you are a higher-rate (40%) taxpayer and make pension contributions by salary sacrifice, they attract 40% tax relief. My question is: Does this rate apply to all your contributions, regardless of how high they are? For example – keeping the figures simple – say your taxable salary after deduction of personal allowance is £32,865. This is £1000 above the £31,865 upper limit of the 20% tax band. You pay £1000 p/a in employee pension contributions, which attract 40% tax relief. If you then increase your contributions by a further £500 p/a, this would come out of the portion of your salary taxed at 20%, so do you only get 20% tax relief on this new pension contribution? Or does it stay at 40% for the whole £1500?

You get the relief equivalent to the tax you would otherwise have paid - so if you would have paid 40% tax only on £1,000 then it's only the first £1,000 of pension contributions that gets tax relief at 40%.

If it's an employer pension that gives tax relief at source, then in order to pay £1,500 into your pension, you'd only see a drop of (£1,000*.60) + (£500*.80) = £1,000 in net income.

Snakey

Comments like "if you are a higher rate taxpayer, you get relief at 40%" are just a convenient shorthand - they're only accurate if you fall squarely into that rate even after making all your pension contributions.

If your contributions take you below the point at which you would otherwise be paying higher rate tax on them, then you will start to get relief at only basic rate from that point onwards.

If there were no considerations other than maximising your tax relief in the current year, and assuming that you'd be declaring all your taxable income, you'd want to make contributions just the right size to take you far enough into the basic rate band to cover your gross taxable investment income (thus ensuring you wouldn't need to pay higher rate tax on your bank interest).

jamesd

You're almost perfectly correct in your example but there's one fiddly detail that can make a difference.

The first £1,000 in your example would get higher rate relief automatically by reducing your income from that job.

The next £500 would take you into basic rate pay at that job so the job payslip itself would only show the saving of the 20% basic rate income tax and also saving you the higher NI in the basic rate pay range.

However, if you also had £500 of taxable savings or investment income you would still be entitled to higher rate income tax relief on the extra £500. You would tell HMRC about this and they would adjust your tax code to give it to you, or in practice just not charge you the extra higher rate income tax on the extra income. So you can get higher rate income tax saving and basic rate NI saving at the same time because the sacrifice uses just the pay in the job, while the income tax uses the total taxable income.

This is how I get both the higher rate income tax relief and the basic rate 12% employee NI saving on around £5,000 of my income.

Aside from the NI issues, the same situation applies to pension contributions not made by salary sacrifice, so you should continue to use salary sacrifice to make the contributions and get the NI benefit.

Seamonster_2

Thanks for the responses - that's really helpful info.