Contributing large bonus into pension and claiming tax relief.

youngy4130

Hi

 I’m hoping somebody can help me out with a slightly complicated question.

I’m currently in the fortunate position of earning £80k. I’m due some considerable changes over the next couple of months. I will be receiving a bonus of £40k in April and my basic wage will increase to £110k in May (with a further potential £48k of bonus for next year).

I have recently been in touch with HMRC to claim higher rate tax relief on previous pension contributions. This led to me getting a considerable amount of Tax relief in my paycheck.

My question is, what is the best thing to do with my £40k bonus. Ideally I’d like to have some of it in cash to spend on travel over the next three years my initial plan was

-          Put £20k straight into pension (Claiming higher rate tax relief)

-          Take £20k through PAYE, effectively being paid £12k after tax.

However, after noticing that my pension tax relief is essentially paid straight to me rather than into my pension, would it make sense to pay the whole £40k into the pension and then claim the tax relief on that (effectively £16k) and take that in ‘cash’?

I then also plan on increasing pension contributions and looking at salary sacrifice benefits to bring my take home pay to below £100k for next year to retain my personal allowance.

I hope this makes sense, I know it’s a bit of a complicated situation. Hope someone can help.

 Thank you!

Dazed_and_C0nfused

You need to understand what method is used.

If It is relief at source then pension tax relief is added to the pension fund, not paid to you.

Conversely any personal tax saving arising from a relief at source pension contribution does come back to you.

There is no pension tax relief with net pay contributions, the tax saving is always received in full by you having less income to pay tax on in the first place.

Do you mean contribute £40k gross (inclusive of the basic rate tax relief) or is that what you would actually pay net under a relief at source scheme?

youngy4130

Its relief at source but I was only getting basic relief I've had to contact HMRC to claim the extra higher rate tax back. That was then given to me through my paycheck as a rebate on my deductions (if that makes sense)

So basically I was suggesting I pay the £40k into pension after tax (as I do now) then claim the tax back and have that come through relief on my tax payments for the year. 

Dazed_and_C0nfused

That would be a gross contribution of £50k.  £40k from you and £10k basic rate tax relief.

Do you have carry forward available to cover the extra £10k?  And that is before your normal contributions are considered.

I don't quite follow your calculations though, how will you get down to sub £100k??

Or does this involve more than one tax year?

I will be receiving a bonus of £40k in April and my basic wage will increase to £110k in May (with a further potential £48k of bonus for next year).

youngy4130

I missed the £40k limit for pensions in my initial thinking. My contributions for this year were £3,500
Next Tax year I will earn 
- £40k bonus in April 
- £110k salary 
- Potential of £36k (total of £48 pa but the last payment would be at the end of April so would miss year end) 

The key thing I'm trying to understand is that if I take a lot of this bonus into pension after tax and claim the higher rate back would it come through my paycheck as it has done for this year after speaking to HMRC?

Dazed_and_C0nfused

It depends on the timing.

At the end of the day on that level of income you will have to complete Self Assessment returns so any additional tax relief will ultimately be finalised when you file your return.

Anything included in your tax code is just provisional so you can essentially choose to get some via your tax code or see all teh benefit when you file your Self Assessment return.  

Either way you get the money, any personal tax saving from a relief at source contribution is never paid into your pension fund.

youngy4130

Ok, cool. 

So basically I decide how much I want to pay into my pension. Notify HMRC to get my higher rate tax and that will comer through to me (End of year if I wait and do self assessment / in my pay if I tell them what I'm going to be paying and adjust my tax code)? 

Thanks for your help, it's all quite confusing.

Dazed_and_C0nfused

Correct.

But you need to make sure you keep to the limits - this might help.
https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/interaction-of-tax-relief-and-annual-allowance/

And if you ever opt to salary sacrifice for pension purposes that means you don't contribute to the pension, you are agreeing to a lower salary in return for your employer contributing more to your pension.  That is why there is no pension tax relief due on salary sacrifice contributions.

And HMRC only ever allow tax relief on pension for the tax year the contribution was paid in.

But they will often update the next year's tax code on the assumption that you make a similar contribution in that next tax year.

For example say you contribute £40k (gross) in 2020:21 then you will ultimately get the full relief due via your 2020:21 Self Assessment return.  If HMRC then adjust your 2021:22 tax code to include pension tax relief it is not allowing relief for the contribution made in 2020:21 but provisionally allowing relief for 2021:22 on the assumption you will pay £40k again in 2021:22.  So it is important you check your tax codes and get them updated if things change

youngy4130

Excellent, thanks for your help! 

I'll spend a little more time on it and review the link you've shared.