Pension tax relief explanation

gingerscot

Hi,

I'm a higher rate tax payer and I'm trying to understand as best I can, how the higher rate tax relief process works for pension contributions.

I've actually phoned up HMRC and got a change to my tax code for last years partial contributions (just 5 months) so I do have a vague enough understanding for them to up my tax free allowance but I want to explain it to a few of my colleagues and when I sit down and explain it too my self i'm getting confused!

I work for a small/medium sized firm. They pay 7%, I pay 7% into a Royal London pension so my understanding is it's a stakeholder pension with relief at source?

On the left of my payslip, I have ER contributions of £291. So that's prior to tax deductions. On the right I have my EE contributions of £233. So that's me paying 80% and then I get 20% tax relief from HMRC and in total I get £582/month in my pension.

As it's relief at source, I have to tell HMRC about my contributions and then my tax code would be raised by £291*0.2 (20% extra tax) * 12 (months) * 5 (to get tax free allowance value?) which works out at ~£3500 above the £12500?

Is that the way it works and an approximate explanation?

Very comfortable with being told I'm completely wrong!

Cheers,

Dazed_and_confused

You are broadly correct but there are a couple of key points you need to understand.

Firstly HMRC will only ever give tax relief for pension contributions in your current tax code for the contributions relating to the current tax year.

If tax relief was due for a different tax year you would get any tax relief due by completing a Self Assessment return or when HMRC reviews your tax records after the end of the tax year (you get a P800 calculation).

Most importantly though there is no "extra 20%".

I'm fact there is no actual "pension tax relief" as such, the gross contribution (yours only, not your employer's) increases the amount of basic rate tax payable which in turn can reduce the amount of intermediate (Scottish resident for tax purposes only) or higher rate tax payable.

A common misconception on here is that you get an "extra 20%". It may be you do get 20% relief if you have paid a lot of higher rate tax but if you were only liable to pay higher rate tax on say £5 then you would only get higher rate tax relief on £5, not the whole of your contribution.

Dazed_and_confused

As it's relief at source, I have to tell HMRC about my contributions and then my tax code would be raised by £291*0.2 (20% extra tax) * 12 (months) * 5 (to get tax free allowance value?) which works out at ~£3500 above the £12500?

It would be quite unusual for that calculation to be correct. As it would mean you are a higher rate payer on your total taxable income but only pay basic rate tax on your job.

The normal tax code calculation, where you are paying more than enough higher rate tax on your employment income, and pay exactly the same £233 net payment in all 12 months would be

£291.25 x 12 = £3,495 gross contribution

Tax relief due = £3,495 x 40% = £1,398 less £699 relief received at source = £699 additional tax relief due

Tax code adjustment = £1,748. Which reduces the higher rate tax you would otherwise be paying (£1,748 x 40% = £699).