Calculating Pension Contribution Tax Relief

0611045

All,

I’m struggling to understand how pension contribution tax relief works. I’m a higher-rate taxpayer, so I need to reclaim the “additional 20%” from HMRC directly. I could, of course, leave the calculation up-to-them, but I like to keep abreast of these things.

Firstly, is it true the calculation of the relief for 20% taxpayers is simply 20% of personal contributions? It seems strange because not all of our income is taxed at 20% - a tax-free allowance gives most of us £11,500 tax-free per year. So we are effectively getting tax relief on taxes not paid.

Second, how would calculating the “additional 20%” work? I assume it’s not as stupid as the 20% rate versus tax-free allowance debacle, where I just get another 20% of contributions. If that were the case, I could earn £1 inside the 40% tax bracket and get relief worth hundreds of pounds. It must be relative to the amount of tax I paid in the 40% bracket.

So, is the calculation:

• Take the amount of income tax paid in the 40% bracket
• Divide by my total income
• Halve it, because 20% relief was already automatically credited by my pension provider
• Multiply by pension contributions for that tax year

So, a worked example. Say I earn £60,000, which means £15,000 is within the higher rate tax bracket and would be taxed at 40%. Tax paid at 40% will be £6,000, and so my total tax at 40% is 10% of my total income (6,000/60,000). I have already been credited with the basic rate portion, so I halve that percentage to 5%. So I can expect a rebate of 5% of my pension contributions in the tax year. Is that right?

Cheers,
Tom

xylophone

http://www.scottishwidows.co.uk/calculators/tax-calculator.html

Dazed_and_confused

You don't actually get a refund of pension tax relief rather your tax is calculated taking into account the pension payment and you get a tax refund based on the difference between the amount of tax you paid during the year and the tax you should have paid.

The pension contribution increases the amount you pay basic rate tax on so if earning £60,000 this has the effect of reducing the amount of 40% tax due.

I'm a bit lost as to how you have tried to calculate the tax relief without actually specifying the amount paid into the pension/sipp??

But in your earning £60,000 example let's say the sipp payment was £10,000 (i.e. you actually paid £8,000 with basic rate tax relief of £2,000 added by the pension company) then the amount taxable at 20% increases from £45,000 to £55,000 (or £43,000 to £53,000 in Scotland) and that saves you another £2,000 as the income from £45,000 to £55,000 is taxed at 20% (so £2,000) rather than 40% (£4,000).

You would hardly ever receive exactly £2,000 though because the tax actually repaid takes into account any other revisions required once the tax year is over.

bigadaj

0611045 wrote: »

All,

I’m struggling to understand how pension contribution tax relief works. I’m a higher-rate taxpayer, so I need to reclaim the “additional 20%” from HMRC directly. I could, of course, leave the calculation up-to-them, but I like to keep abreast of these things.

Firstly, is it true the calculation of the relief for 20% taxpayers is simply 20% of personal contributions? It seems strange because not all of our income is taxed at 20% - a tax-free allowance gives most of us £11,500 tax-free per year. So we are effectively getting tax relief on taxes not paid.

Second, how would calculating the “additional 20%” work? I assume it’s not as stupid as the 20% rate versus tax-free allowance debacle, where I just get another 20% of contributions. If that were the case, I could earn £1 inside the 40% tax bracket and get relief worth hundreds of pounds. It must be relative to the amount of tax I paid in the 40% bracket.

So, is the calculation:

• Take the amount of income tax paid in the 40% bracket
• Divide by my total income
• Halve it, because 20% relief was already automatically credited by my pension provider
• Multiply by pension contributions for that tax year

So, a worked example. Say I earn £60,000, which means £15,000 is within the higher rate tax bracket and would be taxed at 40%. Tax paid at 40% will be £6,000, and so my total tax at 40% is 10% of my total income (6,000/60,000). I have already been credited with the basic rate portion, so I halve that percentage to 5%. So I can expect a rebate of 5% of my pension contributions in the tax year. Is that right?

Cheers,
Tom

It's a lot easier to work things out gross, as dazed and confused has said. If this is a real scenario post your numbers and calculations and someone can check through them and comment as necessary.

In relation to your first point then you are correct, you can get tax relief on income you haven't paid tax on. You won't get this through an employers pension, but will through a personal pension or sipp as this is automatically grossed up by the pension provider by 25%. It's up to you to ensure that the gross sum doesn't exceed your earnings, or actually relevant income on which you can get tax relief for pensions.