Basic rate tax relief via SIPP

arvindsv

Hello!

I searched the forums and I found information explaining how an SIPP contribution expands the 20% basic tax rate band (beyond £37,700). However the confusion I have is regarding tax relief for a basic-rate tax payer.

My assumptions:

1. Self-employment (and so, requirement to file a tax return)
2. Employment income: £15,570

If no private pension contribution is made, then:
- Taxable Profits = £3,000 (ie, £15,570 - £12,570)
- Tax on Profits = £600
- Class 4 and Class 2 NICs of £540 and £159

If a net private pension contribution of £3,000 is made, then:
- Tax relief of £750 is automatically claimed by pension provider (for £3,000)
- Basic tax rate band expands by £3,000, but it's not useful at this level of income (right?)
- Taxable Profits = £3,000 (ie, £15,570 - £12,570)
- Tax on Profits = £600
- Class 4 and Class 2 NICs of £540 and £159

While filing the tax return, even if you show that you've made a gross payment of £3,750 to private pension in the "Tax Reliefs" section of the SA 100, the final tax calculation still shows a tax of £600 to be paid. I understand £750 goes into the pension, but if the same amount is taxed ... then the relief is not £750 but is £750 - £600 = £150, isn't it?

I'm sure I'm very mistaken somehow. I'd be thankful if someone can let me know how and where.

Thank you.

Dazed_and_C0nfused

You are over complicating things.

The pension contribution gets basic rate relief added so £3,000 from you becomes a pension fund of £3,750.

This increases your basic rate band but as you right point out this won't save you any personal income tax.

When you come to take the pension 25% can be taken as a tax free lump sum leaving £2812.50 taxable pension income.  If you are a basic rate taxpayer when taking the taxable element you would have £562.50 tax payable on it.  Less than the tax relief you received in the first place.

Albermarle

When you contribute £3K to the pension provider you have chosen, then the provider requests the basic rate tax relief of £750 from HMRC. When it arrives they add it to your pension. 
Some pension providers pre fund the relief and add it to your pension at the same time as your contribution, whilst others wait until it arrives from HMRC to them ( about 6 weeks ).

arvindsv

Thank you, both. That makes sense.

I think the part I had ignored is that it's tax deferral, not a "20% gain for anything you contribute". It'll be clawed back (possibly at a lower rate) when you withdraw, apart from the 25% tax free part.

When one is at the 40% rate (say £53,270 with a £3,000 pension contribution), you get the other 20% back since 40% is what the tax rate for that £3,000 would have been.

Dazed_and_C0nfused

I think the part I had ignored is that it's tax deferral, not a "20% gain for anything you contribute". It'll be clawed back (possibly at a lower rate) when you withdraw, apart from the 25% tax free part.

It might be for you but there are plenty of people sticking money away each year and getting the basic rate tax relief with absolutely no intention of paying any tax when it's subsequently taken out as income.

If you time things right and it can be a nice little earner, particularly as a bridging pension 😄.

When one is at the 40% rate (say £53,270 with a £3,000 pension contribution), you get the other 20% back since 40% is what the tax rate for that £3,000 would have been.

There is no "other 20%"  Your basic rate band is increase by £3,000 (assuming that's the gross amount, not the net amount you paid the pension company) meaning more income is taxed at 20% and less at 40%.  

It could be worth exactly 20% but it all depends on your overall tax position.