High earner pension tax relief query

aktivemac

I've been trying to understand the way tax relief works for personal pension contributions for higher rate tax payers, and I think I'm missing something. Any help would be really appreciated.

Best way to illustrate my issue is with very simplified worked example. Assuming tax payer is in the 45% tax bracket & ignoring NI, etc.

Gross Marginal Income: £10,000
Tax Due: £4,500
Net Income Received: £5,500.

1) Let's assume Gross Marginal Income is placed straight into a corporate pension scheme. It will go in directly from Gross Marginal Income:

Amount in Pension Scheme = £10,000

2) Now let's assume that Net Income is first received and then invested back into a pension scheme via a personal contribution.

Pension Contribution: £5,500
Pension Scheme Basic Tax Gross-up: £2,000
Total Deposited into Pension Scheme: £7,500

Then claim via Self Assessment Tax Return for the Pension Tax Relief between 20% (Basic) and 45% (Upper) levels.

Credit on Tax Return: £2,500

(Total in Scheme) + (Tax Relief on SA) = £7,500 + £2,500 = £10,000 = Gross Marginal Income

So the the full Gross Marginal Income is accounted for in both scenarios - so far so good...

However...

Under 1), ignoring any tax free lump sum etc, tax will be paid at the tax payer's marginal rate on the full £10,000 when they come to take out of the scheme in retirement

Under 2), the tax payer will pay tax at their marginal rate on the £7,500 when they come to take it out of the scheme at retirement, but it seems to me that the £2,500 they received as a tax relief credit via their SA has effectively been received tax free, no?

As I said, definitely missing something here but the above logic seems sound to me? Help me please, my head is hurting...

Thanks!!

HappyHarry

Not sure you've got part (2) correct:

It should be:

Gross Income £10,000
Tax @ 45% = £4,500
Net income = £5,500

Contribution to Pension = £8,000 (Not just the £5,500 received!)
Tax relief on pension = £2,000
So, total in pension = £10,000

Tax relief claimed via SA = £2,500.

The key is that to get full relief on £10,000, you have to put the full £10,000 in a pension. Pension providers can claim the 20% tax relief, but the individual needs to claim the remainder via SA.

ex-pat_scot

If this is indeed taken from your gross salary, then the full £10,000 will be paid across by your payroll team into your pension pot.
There's no basic gross-up, as no tax has been deducted at source.


If you are one of the few under a "net pay scheme", then 25% would be added to your contribution - the scheme provider would automatically requesdt this from HMRC.
The additional amount, whether you are a higher or additional rate tacpayer, would be identified on your SA form, and your basic rate band would be extended by an appropriate amount that would deliver the remaining tax relief.


The second approach would however deliver only the BR tax into your pot, and would (effectively) give you the remainder of the tax relief back to your bank account. (ie you #should# then transfer said funds into your pension)


Be aware that if you are in the realms of additional relief, then the annual amount you can contribute into your fund is tapered down from £40,000 towards £10,000. The calc itself on tapering is rather complex, and one of the times you really must get some sort of help.

Linton

Pension Contribution: £5,500
Pension Scheme Basic Tax Gross-up: £2,000
Total Deposited into Pension Scheme: £7,500

Your mistake is to assume that the net payment to a pension is equivalent to the value after tax of the gross payment. It should be the value after basic rate tax only.

So if the gross is £10K, for equivalent net purposes you should contribute £8000 net (£5500 taxed income + £2500 of your own) which is grossed up to £10K. As a 45% tax payer you then receive £2.5K highest rate tax refund (45%-20% of gross) via the tax code or as a cheque at the end of the tax year which cancels out your "loan".

aktivemac

Linton wrote: »

Your mistake is to assume that the net payment to a pension is equivalent to the value after tax of the gross payment. It should be the value after basic rate tax only.

So if the gross is £10K, for equivalent net purposes you should contribute £8000 net (£5500 taxed income + £2500 of your own) which is grossed up to £10K. As a 45% tax payer you then receive £2.5K highest rate tax refund (45%-20% of gross) via the tax code or as a cheque at the end of the tax year which cancels out your "loan".

Thanks - I knew I was missing something & this makes sense. I think others above alluded to the same too, so thanks all.