Is this calculation wrong? One off payments into pension and annual allowance carry-back

yellow_barchetta

I'm a higher rate tax payer, with annual earnings (including benefits, taxable interest etc etc) of approx £90k per year, consistently over the last 5 years.

I've got a detailed calculation of my unused annual allowances from my DB pension scheme, which is the only one I've contributed to in the last 5 years too.  For round sum purposes, let's say that that unused allowance is £65k, including the amount projected for this year (say £25k) based on me continuing to earn / contribute in the same way I am at the moment (and getting employer contributions too of course).  

I've recently inherited a sum of £80k and I'm considering depositing some of this cash into and older personal pension fund which I understand will achieve both a) 20% additional contribution into the pension fund and b) the ability to reclaim tax from HMRC for the 40% rate that is my marginal rate.

I'm getting distinctly confused though about the way the 20% / 40% bits work because it feels like I'm creating a magic money tree.

Let's just think about one small chunk of this money, say £10k.  

If I move £10k cash from my bank account and pay it into my personal pension, the pension pot will grow to £12,500 with the 20% relief claimed by the provider (correct?).  But I can also write to the HMRC and achieve a recovery of £4,166 additional HR tax through use of my unused annual allowance.  But then I can (in theory) deposit that £4,166 into the fund too, get 20% top up and reclaim £1,736 HR tax.  And I can do that loop again, and again, and again about 20 times until it turns into pennies, in which case my £10k cash deposit becomes £21,428 increase in the cash in my personal pension fund.

Something seems wrong here in my calculations.  But I've been pondering it all last night and can't see where I've gone wrong!!  Can someone step me through where I've got that wrong?

MK62

You won't get £4166 in HR relief though.......you'll get up to £2500. Your gross payment is £12500, of which you pay £10000 and HMRC add £2500.......you then claim up to a further £2500 via your tax return. However, you can only claim HR tax relief on the amount you actually paid HR tax on........which obviously depends on your salary and pension contributions (and hence relief) to all your pensions.

yellow_barchetta

But surely a net cash payment of £10,000 can only come from gross income of £16,666?  So £6,666 tax paid on £16,666 gross income, taxed at 40%?

(£10,000 / 0.6 = £16,666  £10,000 / 0.8 = £12,500)

yellow_barchetta

Or does the additional relief only come at a rate of 20% because that lifts the personal allowance upwards?  Running the maths I can see that that iterative process of £2,500 both as "top up" and as "reclaim" sums to £16,666, which is ultimately the answer I instinctively expected to be able to increase the pension fund by.

yellow_barchetta

I should have said "widens the 20% band" rather than "lifts the personal allowance upwards" I think?

MK62

yellow_barchetta said:

Or does the additional relief only come at a rate of 20% because that lifts the personal allowance upwards?  Running the maths I can see that that iterative process of £2,500 both as "top up" and as "reclaim" sums to £16,666, which is ultimately the answer I instinctively expected to be able to increase the pension fund by.

You already got half the relief due when HMRC gave you BR relief (£2500)......you claim the other  "up to" 20% via your tax return.

MK62

yellow_barchetta said:

But surely a net cash payment of £10,000 can only come from gross income of £16,666?  So £6,666 tax paid on £16,666 gross income, taxed at 40%?

(£10,000 / 0.6 = £16,666  £10,000 / 0.8 = £12,500)

....but you aren't contributing £16666, you are contributing £12500.

You pay £10000, HMRC add £2500 to your pension in BR tax relief, making a total contribution of £12500.
You claim the other "up to" 20% (£2500) via your tax return, but this is paid to you, not into your pension.......so the effective cost to you of the £12500 contribution is £7500 (the £10000 cash you originally paid, less the HR relief that HMRC pay to you directly)........and £12500 - 40% = £7500.

yellow_barchetta

MK62 said:

yellow_barchetta said:

Or does the additional relief only come at a rate of 20% because that lifts the personal allowance upwards?  Running the maths I can see that that iterative process of £2,500 both as "top up" and as "reclaim" sums to £16,666, which is ultimately the answer I instinctively expected to be able to increase the pension fund by.

You already got half the relief due when HMRC gave you BR relief (£2500)......you claim the other  "up to" 20% via your tax return.

I don't think that's mathematically correct.  The two 20%s don't add together neatly like that.

20% tax of £12,500 = £2,500, £10,000 remainder.
40% tax of £16,666 = £6,666, £10,000 remainder.

If the mechanism that the govt uses simplifies this by effectively applying 25% to both the initial "top up" and any reclaim (if paid in cash) then that's what makes the difference isn't it?

Linton

yellow_barchetta said:

MK62 said:

yellow_barchetta said:

Or does the additional relief only come at a rate of 20% because that lifts the personal allowance upwards?  Running the maths I can see that that iterative process of £2,500 both as "top up" and as "reclaim" sums to £16,666, which is ultimately the answer I instinctively expected to be able to increase the pension fund by.

You already got half the relief due when HMRC gave you BR relief (£2500)......you claim the other  "up to" 20% via your tax return.

I don't think that's mathematically correct.  The two 20%s don't add together neatly like that.

20% tax of £12,500 = £2,500, £10,000 remainder.
40% tax of £16,666 = £6,666, £10,000 remainder.

If the mechanism that the govt uses simplifies this by effectively applying 25% to both the initial "top up" and any reclaim (if paid in cash) then that's what makes the difference isn't it?

"Contribution" means gross of basic rate tax.  So you actually pay in £10000.  The pension company effectively adds in the basic rate tax making a gross contribution of £12500.  If you are a higher rate tax payer you are also due a 20% refund on your contribution of £12500 of £2500 which is paid to you personally, not your pension.

Advice - when you are working out pension payments always work in terms of gross payments and then calculate net.  Not the other way around, otherwise you can get horribly confused.

MK62

If you want to contribute £16666, then you must pay £13333 upfront, to which HMRC will add BR (20%) tax relief of £3333. You may be getting confused because the 20% relief is applied to the gross contribution, not the net contribution you pay in cash. So a gross contribution of £16666 gets 20% tax relief (£3333) and you need to pay £13333 in cash.
You then claim the additional 20% of the gross contribution back from HMRC via your tax return, so HMRC will pay £3333 to you directly (not to your pension).........so the £16666 contribution costs you a net £10000 (the £13333 you paid upfront in cash, less the £3333 in HR relief that HMRC pay directly to you)

This might help.... https://www.hl.co.uk/pensions/tax-relief/calculator

Dazed_and_C0nfused

yellow_barchetta said:

MK62 said:

yellow_barchetta said:

Or does the additional relief only come at a rate of 20% because that lifts the personal allowance upwards?  Running the maths I can see that that iterative process of £2,500 both as "top up" and as "reclaim" sums to £16,666, which is ultimately the answer I instinctively expected to be able to increase the pension fund by.

You already got half the relief due when HMRC gave you BR relief (£2500)......you claim the other  "up to" 20% via your tax return.

I don't think that's mathematically correct.  The two 20%s don't add together neatly like that.

20% tax of £12,500 = £2,500, £10,000 remainder.
40% tax of £16,666 = £6,666, £10,000 remainder.

If the mechanism that the govt uses simplifies this by effectively applying 25% to both the initial "top up" and any reclaim (if paid in cash) then that's what makes the difference isn't it?

Until you take note of what other posters are telling you you will never get this right.

Whatever you pay over (as a relief at source contributions) has 25% added by the pension company.  What your Personal tax situation is is irrelevant, it's always 25%.

So each £100 from you becomes £125 in the pension fund.  There is no other option (for contributions that have tax relief added).