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

yellow_barchetta

Linton said:

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.

But normally when talking gross, we gross up the net by dividing by the marginal rate of tax.  So £10,000 net grossed up would be £16,666.  And I can show that if you are correct (I don't doubt it!) from a pure cashflow perspective I can have a pension pot increase by £16,666 by only depleting my cash balance by £10,000 - it just has to be iterative.

Assuming I have a decent amount of headroom in terms of annual allowance this is how that would work:-
Deposit £10,000 - PP tops up £2,500 - tax relief due £2,500 (let's assume this is paid in cash for simplicity)
Now I iterate
Deposit £2,500 - PP tops up £625 - tax relief due £625
Deposit £625 - PP tops up £156 - tax relief due £156
Deposit £156 - PP tops up £39 - tax relief due £39
Deposit £39 - PP tops up £10 - tax relief due £10
Deposit £10 - PP tops up £2.50 - tax relief due £2.50
Deposit £2.50 - PP tops up £0.62 - tax relief due £0.62
Stop there as we're getting too small!  In the end £16,666 has been added to the pension pot for a diminution of my cash balances of £10,000.  

So as I suggested above, ultimately an effective £16,666 gross contribution to offset against my annual allowance.  Not £15,000.  

I was 100% wrong at first with my calc, but I'm finding it hard to believe my thinking here is wrong.  If I was contributing to a pension fund via a "net pay" approach from my salary, I would se £16,666 deducted from gross, £16,666 added to my pension pot (with no further relief claimed) and £10,000 net cash "reduction" in my payslip (ignoring complexities of NIC or paying tax across bands / thresholds).  

Or am I  really missing something about the tax rates that makes pension deductions different to every other deduction that you might make from gross salary (e.g. professional subscriptions).  

HappyHarry

yellow_barchetta said:

Linton said:

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.

But normally when talking gross, we gross up the net by dividing by the marginal rate of tax.  So £10,000 net grossed up would be £16,666.  And I can show that if you are correct (I don't doubt it!) from a pure cashflow perspective I can have a pension pot increase by £16,666 by only depleting my cash balance by £10,000 - it just has to be iterative.

Assuming I have a decent amount of headroom in terms of annual allowance this is how that would work:-
Deposit £10,000 - PP tops up £2,500 - tax relief due £2,500 (let's assume this is paid in cash for simplicity)
Now I iterate
Deposit £2,500 - PP tops up £625 - tax relief due £625
Deposit £625 - PP tops up £156 - tax relief due £156
Deposit £156 - PP tops up £39 - tax relief due £39
Deposit £39 - PP tops up £10 - tax relief due £10
Deposit £10 - PP tops up £2.50 - tax relief due £2.50
Deposit £2.50 - PP tops up £0.62 - tax relief due £0.62
Stop there as we're getting too small!  In the end £16,666 has been added to the pension pot for a diminution of my cash balances of £10,000.  

So as I suggested above, ultimately an effective £16,666 gross contribution to offset against my annual allowance.  Not £15,000.  

I was 100% wrong at first with my calc, but I'm finding it hard to believe my thinking here is wrong.  If I was contributing to a pension fund via a "net pay" approach from my salary, I would se £16,666 deducted from gross, £16,666 added to my pension pot (with no further relief claimed) and £10,000 net cash "reduction" in my payslip (ignoring complexities of NIC or paying tax across bands / thresholds).  

Or am I  really missing something about the tax rates that makes pension deductions different to every other deduction that you might make from gross salary (e.g. professional subscriptions).  

That is correct.

It might just be easier to make a net payment of £13,333.33 to your pension fund, which will be grossed up to £16,666.66 and give you £3,333.33 to claim back via self assessment. This leaves you with £16666.66 in your pension for a cost to you of £10,000. (NI contributions ignored).

zagfles

yellow_barchetta said:

Linton said:

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.

But normally when talking gross, we gross up the net by dividing by the marginal rate of tax.  So £10,000 net grossed up would be £16,666.  And I can show that if you are correct (I don't doubt it!) from a pure cashflow perspective I can have a pension pot increase by £16,666 by only depleting my cash balance by £10,000 - it just has to be iterative.

Assuming I have a decent amount of headroom in terms of annual allowance this is how that would work:-
Deposit £10,000 - PP tops up £2,500 - tax relief due £2,500 (let's assume this is paid in cash for simplicity)
Now I iterate
Deposit £2,500 - PP tops up £625 - tax relief due £625
Deposit £625 - PP tops up £156 - tax relief due £156
Deposit £156 - PP tops up £39 - tax relief due £39
Deposit £39 - PP tops up £10 - tax relief due £10
Deposit £10 - PP tops up £2.50 - tax relief due £2.50
Deposit £2.50 - PP tops up £0.62 - tax relief due £0.62
Stop there as we're getting too small!  In the end £16,666 has been added to the pension pot for a diminution of my cash balances of £10,000.  

So as I suggested above, ultimately an effective £16,666 gross contribution to offset against my annual allowance.  Not £15,000.  

I was 100% wrong at first with my calc, but I'm finding it hard to believe my thinking here is wrong.  If I was contributing to a pension fund via a "net pay" approach from my salary, I would se £16,666 deducted from gross, £16,666 added to my pension pot (with no further relief claimed) and £10,000 net cash "reduction" in my payslip (ignoring complexities of NIC or paying tax across bands / thresholds).  

Or am I  really missing something about the tax rates that makes pension deductions different to every other deduction that you might make from gross salary (e.g. professional subscriptions).  

What are you trying to prove? RAS gives the same end result as net pay? That's how it's supposed to work. It's just the cashflow that's different. 

Instead of the above silly iterative process you could just pay in £13,333 into the RAS pension. Then the gross contribution is £16,666 and you claim back £3,333 on your tax return. Exactly the same end result. £16,666 in your pension at a net cost to you of £10,000 

The reason RAS works in the way it does is to make life simple for basic rate taxpayers, who are the majority (albeit a shrinking one). They don't need to do anything more. 

Linton

We have explained exactly how tax rebates and pension payments work. I believe the reason it works like that is so that the great majority of people in employment can pay regular and ad hoc amounts into their employer's and personal pensions and be taxed correctly with minimal admin effort and without any need to complete SA forms. the end result is the same.

 You will find that minimising admin is a significant factor in the design of other aspects of the tax system.  If you want it to work differently you will need to discuss the matter with your MP.

yellow_barchetta

Ah, now that is the shortcut I was looking for!!!

So, if I have £50k of unused (gross) annual allowance available for "one off" payments into the pension fund, my calculation should be (in cash terms) to put £40k into the fund (cash goes down), claim £10k back via HMRC (cash goes up) and £50k would be added to my pension pot - with nothing else to do, at a net cost of £30k cash.  

zagfles

yellow_barchetta said:

Ah, now that is the shortcut I was looking for!!!

So, if I have £50k of unused (gross) annual allowance available for "one off" payments into the pension fund, my calculation should be (in cash terms) to put £40k into the fund (cash goes down), claim £10k back via HMRC (cash goes up) and £50k would be added to my pension pot - with nothing else to do, at a net cost of £30k cash.  

Not if you earn £90k, then you won't get the full 40% tax relief on £50k. Only £40k approx will be in higher rate tax. So you'd get about £8k back. 

yellow_barchetta

@Linton and @zagfles you are absolutely right  (and thanks for your help!), but sometimes it's useful to get ones head around it.  And if was wanting to make sure that I used my full 3 years of unused annual allowance, for example, it's important to get the right gross to net calculation, isn't it?  I know precisely how much unused AA I have (from info from my pension provider), so now I also know precisely how to convert that into one or more payments into a pension fund too.

Surely the point of discussing things here might be to optimise claims etc.  If I'd followed the advice of @MK62
on here I'd have been grossing £10,000 up to £15,000, assuming £15,000 was the amount being set off against my annual allowance and therefore carrying forward (on a spreadsheet, at the very least) an incorrect amount of AA unused.  Getting it right (£10000 / 0.6) has some importance, doesn't it? 

I've also now understood your point about simplicity, which I agree with!

yellow_barchetta

zagfles said:

yellow_barchetta said:

Ah, now that is the shortcut I was looking for!!!

So, if I have £50k of unused (gross) annual allowance available for "one off" payments into the pension fund, my calculation should be (in cash terms) to put £40k into the fund (cash goes down), claim £10k back via HMRC (cash goes up) and £50k would be added to my pension pot - with nothing else to do, at a net cost of £30k cash.  

Not if you earn £90k, then you won't get the full 40% tax relief on £50k. Only £40k approx will be in higher rate tax. So you'd get about £8k back. 

Yes, that's of course correct.  I wish I earned more ;-) 

Dazed_and_C0nfused

yellow_barchetta said:

Ah, now that is the shortcut I was looking for!!!

So, if I have £50k of unused (gross) annual allowance available for "one off" payments into the pension fund, my calculation should be (in cash terms) to put £40k into the fund (cash goes down), claim £10k back via HMRC (cash goes up) and £50k would be added to my pension pot - with nothing else to do, at a net cost of £30k cash.  

Nope, being a higher rate payer doesn't entitled you to higher rate relief on whatever you choose to pay.

You might only be paying higher rate tax on £1, should you get higher rate relief on £50k then??

The gross contribution (£50k in your example) simply increases your basic rate band by £50k, so yours would be £87,700 not £37,700.

As you are only using ~£77k of your basic rate band your higher rate relief is limited by that.

yellow_barchetta

zagfles said:

yellow_barchetta said:

Ah, now that is the shortcut I was looking for!!!

So, if I have £50k of unused (gross) annual allowance available for "one off" payments into the pension fund, my calculation should be (in cash terms) to put £40k into the fund (cash goes down), claim £10k back via HMRC (cash goes up) and £50k would be added to my pension pot - with nothing else to do, at a net cost of £30k cash.  

Not if you earn £90k, then you won't get the full 40% tax relief on £50k. Only £40k approx will be in higher rate tax. So you'd get about £8k back. 

But if I can use previous years' unused allowances, would that not help?  Or can I only get relief at the marginal rate in the year that I make the deposit?  That does make sense, but wasn't quite where I thought it was going in my head!