Can pension tax relief exceed tax paid?

koru

Can anyone confirm what happens if the basic rate tax relief on a pension contribution exceeds the tax liability? Everything I can find says that the limit on contributions qualifying for tax relief (below the £40k annual allowance) is 100% of the earnings, but what if tax isn't paid on some of those earnings, because the first £11k of income is not taxable?

If you don't pay any tax, then you can only get tax relief on £2880 of contribution, but what if you do pay some tax, but not enough to equal the tax relief?

eg, assume Mr/Mrs X has earnings of £12k and makes a cash contribution of £6k to their SIPP.

After deducting the £11k personal allowance, X has taxable income of £1k, so tax to pay is £200.

The SIPP provider claims tax relief of 20% from the government, which is £1500. This is added to the pension. But is it allowed to claim £1500 tax relief after paying only £200 of tax?

zagfles

koru wrote: »

Can anyone confirm what happens if the basic rate tax relief on a pension contribution exceeds the tax liability? Everything I can find says that the limit on contributions qualifying for tax relief (below the £40k annual allowance) is 100% of the earnings, but what if tax isn't paid on some of those earnings, because the first £11k of income is not taxable?

Yes you can get tax relief at basic rate for contributions that take your income below the personal allowance, ie you get more "tax relief" than the tax you paid. As long as you stick to the "100% of earnings or £3600 if greater" tax relief limit. And it only works with a RAS scheme, if it's a net pay scheme (ie where pension conts are deducted before tax on the payslip) or salary sacrifice you won't get tax relief below the PA.

If you don't pay any tax, then you can only get tax relief on £2880 of contribution, but what if you do pay some tax, but not enough to equal the tax relief?

eg, assume Mr/Mrs X has earnings of £12k and makes a cash contribution of £6k to their SIPP.

After deducting the £11k personal allowance, X has taxable income of £1k, so tax to pay is £200.

The SIPP provider claims tax relief of 20% from the government, which is £1500. This is added to the pension. But is it allowed to claim £1500 tax relief after paying only £200 of tax?

Yes. Assuming the £12k is "relevant earnings" which basically means employment income and similar (not investment income, pensions etc).

bowlhead99

Yes, you don't need to have paid any tax at all to receive basic rate tax relief using the 'relief at source' method when putting money into a pension. It is an incentive to contribute to your pension.

Even if your relevant earnings are zero you can contribute a standard level of £3600 gross by making a £2880 contribution and obtaining £720 of basic rate relief at source which the pension provider collects on your behalf.

If your relevant earnings are higher than £3600, you can do more than £3600, with your relevant earnings usually being the limit (until you hit other limits unrelated to earnings such as the annual £40k limit or other limit for people who have already started drawing pensions and lump sums etc).

So if you earn £10k or £11k or £12k there is no problem making a net contribution of 80% of those figures and having it grossed up by the pension provider using the relief at source method to get the full £10k or £11k or £12k sitting inside a pension, even though that relief will be greater than the tax you have actually paid on your £10k or £11k or £12k of income.

What you *wouldn't* want to do if you were earning £12k would be to ask your employer to make a gross contribution of £12k into your pension instead of taking the salary because, as you mentioned, there is virtually no actual tax to be saved on not taking the salary whereas there is £2.4k of tax relief to be had by contributing £9.6k to a pension that operates relief at source and having them gross it up to £12k for you.

- Hmm, seems zagfles beat me to it, but we're in agreement on that; the rules have been in place like that for years.

koru

Thanks, both, for the warning about the employer contribution. But there is NI to take into account, isn't there?

By taking £12k employer contribution, you save (I think) £471 employer NI, £416 employee NI and the income tax on the part of the salary above £11k.

By taking salary instead and then making your own contribution you get 20% tax relief, but you pay the extra NI and IT.

So, I guess the optimum is to take enough salary to use the £11k personal allowance, then employer contribution for anything above that? (Because you will be paying tax on the salary in excess of £11k at 20%, plus 12% e'ee NI. And your employer will pay 13.8% NI, unless NI allowance applies.)

bigadaj

koru wrote: »

Thanks, both, for the warning about the employer contribution. But there is NI to take into account, isn't there?

By taking £12k employer contribution, you save (I think) £471 employer NI, £416 employee NI and the income tax on the part of the salary above £11k.

By taking salary instead and then making your own contribution you get 20% tax relief, but you pay the extra NI and IT.

So, I guess the optimum is to take enough salary to use the £11k personal allowance, then employer contribution for anything above that? (Because you will be paying tax on the salary in excess of £11k at 20%, plus 12% e'ee NI. And your employer will pay 13.8% NI, unless NI allowance applies.)

Yes, that's about right but there's also the consideration of paying enough NI to be credited for years towards the state pension.

zagfles

koru wrote: »

Thanks, both, for the warning about the employer contribution. But there is NI to take into account, isn't there?

By taking £12k employer contribution, you save (I think) £471 employer NI, £416 employee NI and the income tax on the part of the salary above £11k.

By taking salary instead and then making your own contribution you get 20% tax relief, but you pay the extra NI and IT.

So, I guess the optimum is to take enough salary to use the £11k personal allowance, then employer contribution for anything above that? (Because you will be paying tax on the salary in excess of £11k at 20%, plus 12% e'ee NI. And your employer will pay 13.8% NI, unless NI allowance applies.)

You only get NI relief with salary sacrifice arrangements, and you can't sal sac below the national minimum wage so that's about £15k for a full timer (depending on exact hours).

Don't confuse sal sac with "net pay" arrangements, this is traditionally how employee pension contributions are made, you get tax relief in your payslip but not NI relief. With "net pay" you can go below NMW. But you won't get tax relief if you go below the personal allowance.

With RAS schemes, this is mostly personal pensions but some employer schemes use a RAS scheme, eg group personal pensions, you get no tax relief (or NI relief) in your payslip but the scheme reclaims basic rate tax. Here you can get tax relief even if you go below the PA.

koru

bigadaj wrote: »

Yes, that's about right but there's also the consideration of paying enough NI to be credited for years towards the state pension.

Yes, but you aren't saying this means optimal salary is more than £11k, are you? You only need salary of more than £5824 pa to earn a year for state pension. So, you were just pointing out that another disadvantage of 100% employer pension cont is that you don't earn a state pension year.

koru

zagfles wrote: »

you can't sal sac below the national minimum wage so that's about £15k for a full timer (depending on exact hours).

Yes, although I think NMW does not apply if they are an office-holder of the company, with no employment contract.

koru

zagfles wrote: »

You only get NI relief with salary sacrifice arrangements, and you can't sal sac below the national minimum wage so that's about £15k for a full timer (depending on exact hours).

Don't confuse sal sac with "net pay" arrangements, this is traditionally how employee pension contributions are made, you get tax relief in your payslip but not NI relief. With "net pay" you can go below NMW. But you won't get tax relief if you go below the personal allowance.

With RAS schemes, this is mostly personal pensions but some employer schemes use a RAS scheme, eg group personal pensions, you get no tax relief (or NI relief) in your payslip but the scheme reclaims basic rate tax. Here you can get tax relief even if you go below the PA.

If the person in question is a director who controls the company, they can, I think, decide what the salary is (as long as the combined remuneration does not exceed a reasonable reward for the work done), and can decide to sacrifice up to 100% of it as pension contributions. (Subject to NMW, if relevant.)

koru

One more question: To do a salary/bonus sacrifice, must there be a contractual right to the salary/bonus that is sacrificed? So, must there be an employment contract giving the right to the salary or to a bonus? (A director or other company officer might not have an employment contract.)

System

koru wrote: »

If the person in question is a director who controls the company, they can, I think, decide what the salary is (as long as the combined remuneration does not exceed a reasonable reward for the work done), and can decide to sacrifice up to 100% of it as pension contributions. (Subject to NMW, if relevant.)

If the company makes employer pension contributions on behalf of a director then the salary is irrelevant. The only limit is the £40,000, plus any carry-forward. The company receives the tax relief, not the individual, and the usual rules for offsetting against corporation tax apply - ie the payment must be of benefit to the company.
That could for example be remuneration by a now- established company in compensation for minimal remuneration during the formative years.