Does increasing pension contributions avoid tax?

Prism

penners324 said:

Why limit your take home pay in that way? 

Why pay tax on take home pay you might not need. If you need every penny of what you earn then skip the pension, but for most that would be a poor plan in the long run.

Albermarle

OP - In summary - you need to answer the question of Xylophone before any more sensible comments can be made.
Is tax relief on your workplace pension given through "net pay" or "relief at source"?
https://www.nowpensions.com/help-centre/faqs/general-information/whats-the-difference-between-net-pay-and-relief-at-source

bargainhunter888

can someone explain this? assuming it's salary sacrifice,
Where an employee in a scheme operating relief at source is a higher or additional rate taxpayer they can claim back the rest of the tax relief themselves from HMRC either by writing to them separately or through their annual self-assessment tax return.
what can be claimed back? because if it's done at source you're automatically not paying the 20% or 40% income tax because it's been taken out of your pensionable salary.
if someone could post examples with figures to demonstrate that would be useful, i'm contemplating doing additional voluntary contributions

kuratowski

That note is describing a different arrangement, which is not the same as salary sacrifice.

"Relief at source" is when you make a payment into a pension scheme from your net earnings (after tax) and the scheme provider claims the basic rate tax relief from HMRC on your behalf and adds it to your pot.  Then, as the note describes, as a HR or AR taxpayer you would need to separately claim any entitlement to HR or AR relief from HMRC via your personal tax account or, where applicable, self-assessment.  This would apply for some employers and also for any personal pension contributions you made directly, without going through your payroll.

However, with either a "net pay" arrangement or salary sacrifice, the pension payment is taken from your gross earnings (before tax) so you automatically get whatever HR or AR relief you are entitled to.  The principal difference between net pay and salary sacrifice is the NI treatment, i.e. with salary sacrifice the pension payment never counts as part of your earnings at all and so no NI contributions are due on it, from either your employer or yourself.

bowlhead99

bargainhunter888 said:

can someone explain this? assuming it's salary sacrifice,
Where an employee in a scheme operating relief at source is a higher or additional rate taxpayer they can claim back the rest of the tax relief themselves from HMRC either by writing to them separately or through their annual self-assessment tax return.
what can be claimed back? because if it's done at source you're automatically not paying the 20% or 40% income tax because it's been taken out of your pensionable salary.
if someone could post examples with figures to demonstrate that would be useful, i'm contemplating doing additional voluntary contributions

You are just misunderstanding the terminology:

A 'relief at source' scheme means you are using money out of your net pay to make some additional contributions to the scheme, and basic rate relief will straight away be claimed by the provider from HMRC. By contributions out of net pay, I mean your gross salary has already been taxed on your payslip, and the payments to the pension firm are paid out of the net-of-tax money that is left - which could have  all gone to your bank account if you were not making contributions

The provider, upon receiving the cash (which was paid to it out of your net-of-tax pay) will go to HMRC and claim basic rate tax relief. For every £80 the pension company takes from you, the pension company will immediately claim £20, because effectively the money going into the pot has come from you, out of your own already-taxed money, and that tax needs to be 'relieved' to get a bigger gross amount in the pension pot (£100 of gross pension pot for every £80 of contributions).  Although, they are only allowed to claim the basic rate gross-up, because they don't know your full personal tax situation, and if you need higher rate relief you will need to inform HMRC and pursue that element of it yourself.

In your example, of "salary sacrifice" the method of making contributions is by sacrificing salary and saying to your employer that you don't want the gross salary at all. As your employer changes your contract to not pay you the high level of gross pay for the work you do for him - and instead pay you some lower level of pay, and more employer pension contributions instead - it is true that you are 'automatically not paying' tsome taxes that would have otherwise been due, because you are not getting as much gross pay. You would simply be taxed correctly on your lower gross pay, and no relief can be claimed on that because you have paid the correct amount of tax. The untaxed money that the employer puts into the pot, as gross contribution from their own bank account, just goes direct to the provider where it is dumped into your pension pot.

So on a contribution made by way of salary sacrifice, the provider does not claim any relief, because the source was the employer's own funds, which have not suffered any payroll taxes and do not need any relief -  rather than being net-of-tax money that was on your payslip and destined for the employee's bank account. 

Whereas on a contribution made outside salary sacrifice, the money was on the net side of your payslip and would have gone to your bank account for you to freely spend, and you agree for it to be deducted from that net money and sent to the pension provider; the pension provider will claim basic relief for you.

Example 1 (ignoring NI to keep the percentages nice and clean):
You earn £80000 so are well into high rate tax.
You join a pension scheme by way of salary sacrifice, agreeing to contribute 12.5%, £10,000. 
The employer changes your gross pay to £70,000 and gives £10,000 to the pension provider for your pot.
As your gross pay is £10,000 lower, the income tax you pay is £4000 lower (40%) and your net pay drops by £6000. No 'relief' is needed, you will simply pay the correct tax on your lower salary.

Example 2
Facts same as example 1. You decide you would like to get more money into your pension so you agree with your employer to take even more money off you by way of £2000 salary sacrifice.
They take your salary down further, to £68000, and give the pension provider an extra £2000 for your pot.
As your gross pay is £2000 lower, you will save £800 tax (40%) and your net pay drops by £1200.  No 'relief' needed, you will simply pay the correct tax.

Example 3
Facts same as example 1, where you have agreed to be 'earning' £70,000 and getting a large additional £10000 sal-sac pension contribution on the side.
You decide to make an extra pension contribution and it will not be by way of salary sacrifice but simply out of the net pay you were going to get.
You agree to have £1600 taken from your net pay and given to the pension company.
The pension company receives the £1600 and claims basic rate relief-at-source on your behalf, collecting £400 from the taxman and adding it to your pension pot, giving £2000 in the pot.

In example 3, as your gross pay was unchanged, the tax you pay via payroll is unchanged. However, part of that tax you paid  via payroll has been relieved by the operation of the pension provider's 'relief at source' claim, because you have got £2000 in the pension for a cost of only £1600.  But you know that as a higher rate  40% taxpayer, a £2000 pension investment should only really cost you £1200 net, and you have paid £1600, which is too much.

So to resolve this problem you tell HMRC that the amount of your extra pension contribution and basic rate tax relief was £2000.  They agree to extend the 'basic rate band' by £2000 (e.g. from £50k to £52k) so that £2000 of income that was going to be taxed at 40% will now only be taxed at 20%. This will save you 20% of £2000 i.e. £400.

If your PAYE code was not adjusted during the year for this (i.e. you were still paying tax at 'normal' rates on your £70,000 salary despite making this additional pension contribution on the side), you will have overpaid £400 tax, and HMRC will send you a cheque or a direct transfer to your bank account.

- So in example 2 (extra contribution via sacrifice) the reduction of salary got you £2000 of pension investment during the year and reduced your net-of-tax pay by £1200 during the course of the year.

- While example 3  (salary unchanged, additional contribution from net pay), the extra contribution got you £2000 of pension investment during the year and reduced your net-of-tax pay by £1600 during the course of the year, but HMRC gave you £400 back outside the pension at the end of the year, so the overall effect on your bank account is still £1200 and the overall effect on your pension is still £2000.

So, that's how tax relief works. In real life, example 2 is better than example 3 if the employer offers this method, because dropping your salary by £2000 saves 2% of employee's national insurance (£40), improving your net pay... and sometimes employers are grateful for your lower salary saving their own employer's national insurance bill, and will happily give you some of that money as a further contribution into your pension too.

bargainhunter888

kuratowski said:

That note is describing a different arrangement, which is not the same as salary sacrifice.

"Relief at source" is when you make a payment into a pension scheme from your net earnings (after tax) and the scheme provider claims the basic rate tax relief from HMRC on your behalf and adds it to your pot.  Then, as the note describes, as a HR or AR taxpayer you would need to separately claim any entitlement to HR or AR relief from HMRC via your personal tax account or, where applicable, self-assessment.  This would apply for some employers and also for any personal pension contributions you made directly, without going through your payroll.

However, with either a "net pay" arrangement or salary sacrifice, the pension payment is taken from your gross earnings (before tax) so you automatically get whatever HR or AR relief you are entitled to.  The principal difference between net pay and salary sacrifice is the NI treatment, i.e. with salary sacrifice the pension payment never counts as part of your earnings at all and so no NI contributions are due on it, from either your employer or yourself.

thanks, personally looking at my situation, my pension is deducted before tax, therefore i assume the deducted amount is the same amount that goes into the pension, there is no additional 20% added.
the 20% added is only true if it came out of my post tax income? ie £100 after 20% tax my net pay is £80 and let's say £20 is contributed to the pot, then they claim the £5 from HMRC then add it separately?

ColdIron

Yes, yes and yes

bargainhunter888

bowlhead99 said:

bargainhunter888 said:

can someone explain this? assuming it's salary sacrifice,
Where an employee in a scheme operating relief at source is a higher or additional rate taxpayer they can claim back the rest of the tax relief themselves from HMRC either by writing to them separately or through their annual self-assessment tax return.
what can be claimed back? because if it's done at source you're automatically not paying the 20% or 40% income tax because it's been taken out of your pensionable salary.
if someone could post examples with figures to demonstrate that would be useful, i'm contemplating doing additional voluntary contributions

You are just misunderstanding the terminology:

A 'relief at source' scheme means you are using money out of your net pay to make some additional contributions to the scheme, and basic rate relief will straight away be claimed by the provider from HMRC. By contributions out of net pay, I mean your gross salary has already been taxed on your payslip, and the payments to the pension firm are paid out of the net-of-tax money that is left - which could have  all gone to your bank account if you were not making contributions

The provider, upon receiving the cash (which was paid to it out of your net-of-tax pay) will go to HMRC and claim basic rate tax relief. For every £80 the pension company takes from you, the pension company will immediately claim £20, because effectively the money going into the pot has come from you, out of your own already-taxed money, and that tax needs to be 'relieved' to get a bigger gross amount in the pension pot (£100 of gross pension pot for every £80 of contributions).  Although, they are only allowed to claim the basic rate gross-up, because they don't know your full personal tax situation, and if you need higher rate relief you will need to inform HMRC and pursue that element of it yourself.

In your example, of "salary sacrifice" the method of making contributions is by sacrificing salary and saying to your employer that you don't want the gross salary at all. As your employer changes your contract to not pay you the high level of gross pay for the work you do for him - and instead pay you some lower level of pay, and more employer pension contributions instead - it is true that you are 'automatically not paying' tsome taxes that would have otherwise been due, because you are not getting as much gross pay. You would simply be taxed correctly on your lower gross pay, and no relief can be claimed on that because you have paid the correct amount of tax. The untaxed money that the employer puts into the pot, as gross contribution from their own bank account, just goes direct to the provider where it is dumped into your pension pot.

So on a contribution made by way of salary sacrifice, the provider does not claim any relief, because the source was the employer's own funds, which have not suffered any payroll taxes and do not need any relief -  rather than being net-of-tax money that was on your payslip and destined for the employee's bank account. 

Whereas on a contribution made outside salary sacrifice, the money was on the net side of your payslip and would have gone to your bank account for you to freely spend, and you agree for it to be deducted from that net money and sent to the pension provider; the pension provider will claim basic relief for you.

Example 1 (ignoring NI to keep the percentages nice and clean):
You earn £80000 so are well into high rate tax.
You join a pension scheme by way of salary sacrifice, agreeing to contribute 12.5%, £10,000. 
The employer changes your gross pay to £70,000 and gives £10,000 to the pension provider for your pot.
As your gross pay is £10,000 lower, the income tax you pay is £4000 lower (40%) and your net pay drops by £6000. No 'relief' is needed, you will simply pay the correct tax on your lower salary.

Example 2
Facts same as example 1. You decide you would like to get more money into your pension so you agree with your employer to take even more money off you by way of £2000 salary sacrifice.
They take your salary down further, to £68000, and give the pension provider an extra £2000 for your pot.
As your gross pay is £2000 lower, you will save £800 tax (40%) and your net pay drops by £1200.  No 'relief' needed, you will simply pay the correct tax.

Example 3
Facts same as example 1, where you have agreed to be 'earning' £70,000 and getting a large additional £10000 sal-sac pension contribution on the side.
You decide to make an extra pension contribution and it will not be by way of salary sacrifice but simply out of the net pay you were going to get.
You agree to have £1600 taken from your net pay and given to the pension company.
The pension company receives the £1600 and claims basic rate relief-at-source on your behalf, collecting £400 from the taxman and adding it to your pension pot, giving £2000 in the pot.

In example 3, as your gross pay was unchanged, the tax you pay via payroll is unchanged. However, part of that tax you paid  via payroll has been relieved by the operation of the pension provider's 'relief at source' claim, because you have got £2000 in the pension for a cost of only £1600.  But you know that as a higher rate  40% taxpayer, a £2000 pension investment should only really cost you £1200 net, and you have paid £1600, which is too much.

So to resolve this problem you tell HMRC that the amount of your extra pension contribution and basic rate tax relief was £2000.  They agree to extend the 'basic rate band' by £2000 (e.g. from £50k to £52k) so that £2000 of income that was going to be taxed at 40% will now only be taxed at 20%. This will save you 20% of £2000 i.e. £400.

If your PAYE code was not adjusted during the year for this (i.e. you were still paying tax at 'normal' rates on your £70,000 salary despite making this additional pension contribution on the side), you will have overpaid £400 tax, and HMRC will send you a cheque or a direct transfer to your bank account.

- So in example 2 (extra contribution via sacrifice) the reduction of salary got you £2000 of pension investment during the year and reduced your net-of-tax pay by £1200 during the course of the year.

- While example 3  (salary unchanged, additional contribution from net pay), the extra contribution got you £2000 of pension investment during the year and reduced your net-of-tax pay by £1600 during the course of the year, but HMRC gave you £400 back outside the pension at the end of the year, so the overall effect on your bank account is still £1200 and the overall effect on your pension is still £2000.

So, that's how tax relief works. In real life, example 2 is better than example 3 if the employer offers this method, because dropping your salary by £2000 saves 2% of employee's national insurance (£40), improving your net pay... and sometimes employers are grateful for your lower salary saving their own employer's national insurance bill, and will happily give you some of that money as a further contribution into your pension too.

on the left side of my payslip is my total salary, less Salary Exchange = total Pay, then Deductions on the left.
i assume that i'm still on Sal Sac as mentioned by my employer, i think the bit where you mention the below about employer changing my gross pay to £70k, 
in actual fact on the pay slip its £80k less £10k = £70k.
is that right

You earn £80000 so are well into high rate tax.
You join a pension scheme by way of salary sacrifice, agreeing to contribute 12.5%, £10,000. 
The employer changes your gross pay to £70,000 and gives £10,000 to the pension provider for your pot. 
As your gross pay is £10,000 lower, the income tax you pay is £4000 lower (40%) and your net pay drops by £6000. No 'relief' is needed, you will simply pay the correct tax on your lower salary.

Dazed_and_C0nfused

bargainhunter888 said:

kuratowski said:

That note is describing a different arrangement, which is not the same as salary sacrifice.

"Relief at source" is when you make a payment into a pension scheme from your net earnings (after tax) and the scheme provider claims the basic rate tax relief from HMRC on your behalf and adds it to your pot.  Then, as the note describes, as a HR or AR taxpayer you would need to separately claim any entitlement to HR or AR relief from HMRC via your personal tax account or, where applicable, self-assessment.  This would apply for some employers and also for any personal pension contributions you made directly, without going through your payroll.

However, with either a "net pay" arrangement or salary sacrifice, the pension payment is taken from your gross earnings (before tax) so you automatically get whatever HR or AR relief you are entitled to.  The principal difference between net pay and salary sacrifice is the NI treatment, i.e. with salary sacrifice the pension payment never counts as part of your earnings at all and so no NI contributions are due on it, from either your employer or yourself.

thanks, personally looking at my situation, my pension is deducted before tax, therefore i assume the deducted amount is the same amount that goes into the pension, there is no additional 20% added.
the 20% added is only true if it came out of my post tax income? ie £100 after 20% tax my net pay is £80 and let's say £20 is contributed to the pot, then they claim the £5 from HMRC then add it separately?

There is never an additional 20% added.

If you contribute £80 to a relief at source pension such as a SIPP or personal pension then the pension company (courtesy of HMRC) adds 25% to make a gross contribution of £100.  Your contribution is 80% of the gross payment with 20% tax relief being added.

Mutton_Geoff

penners324 said:

Why limit your take home pay in that way? 

Because if you are a high rate tax payer, you could take £10,000 as pay and get taxed/NI'd and be left with £5,800 in your pocket. Or have the full £10,000 in your pension pot. Better still if your company offers a scheme to refund their saved employers NI on that amount. My employer offers a 10% uplift for this, so I can either take home £5,800 or have £11,000 put in my pension pot for the same cost.

Almost doubling my money overnight is a no brainer. Of course there will be tax to pay on the pension but if that's at standard rate, then assuming zero growth in my pension fund, I can have £5,800 now or £8,800 later.

That's why people choose to limit their take home pay in this way. There is also the powerful psychology that if you never had it, you never missed it.