HMRC is TAXING certain Pension CONTRIBUTIONS

apn64

TL/DR: HMRC is withholding 10% of Pension Contributions made by Higher-Rate taxpayers using after-tax income to contribute to a registered pension plan (incl. workplace pensions).
 

Not withstanding the tax-free lump sum rules, it's my understanding is that for Registered Pension Plans, HMRC taxes withdrawals and on that basis, contributions are tax-exempt.

While I realise there's not a not a lot of sympathy for Higher-Rate taxpayers, apologies if I'm the bearer of bad news, but at the present time, the bold text (above) is not always true for Higher-Rate taxpayers.

Subject to annual contribution limits, I'm aware of TWO common methods of contributing to registered pension plans (including SIPP's);

1. Salary Sacrifice
2. After-Tax Income

Either of these methods can be used for (regular) payroll deduction and occasional top-up payments to a registered pension plan.

For the avoidance of doubt, Salary Sacrifice is the most tax-efficient method of contributing to a pension plan. This is both from an Income Tax and National Insurance POV. In the latter case, you not only save NI premiums, but your employer often passes on their savings as additional pension contribution.

Unfortunately, I've discovered that contributing to a pension plan from after-tax income is fraught with problems, including right off the bat, you may not get the additional NI premiums refunded. However, I believe that I've found (and experienced) a major problem in the way that HMRC refunds taxes paid on after-tax pension contributions made by Higher-Rate taxpayers.

Unfortunately, I need to switch to some high-school algebra to explain the situation;

PC = Pension Contribution
PTI = Pre-Tax Income
TR = Tax Rate
TP = Tax Paid

1. Since we're dealing with After-Tax Income, PC = PTI - TP
2. Rearranging (1) above, TP = PTI - PC
3. Since TP = PTI*TR, we can say that PC = PTI*(1-TR)
4. Substituting PTI in (3) we get TP = PC / (1-TR) - PC, so TP = PC*(1/(1-TR) -1)

Using fractions for Tax Rate simplifies the algebra, so we'll use 1/5 for the 20% Basic Rate and 2/5 for the 40% Higher Rate.

Thus for a given Pension Contribution, the Basic-Rate payer has paid PC*(5/4 - 1) = PC * 1/4 in tax.

Similarly, the Higher-Rate payer has paid PC*(5/3-1) = PC*2/3 in tax.

From the above, we can see that for a £1,000 pension contribution, the Basic-Rate payer would have paid £250 tax and the Higher-Rate payer would have paid $666.67 tax.

i.e.  £1,250 * 20% = £1,000 in after-tax income
and £1,666.67 * 40% = £1,000 in after-tax income.


For the avoidance of doubt, the issue here is not the above, but the method used by HMRC to calculate tax refunds for Higher-Rate payers (there's NO problem for Basic-Rate payers).

Rather than refund the PC*2/3 in one-shot, HMRC provides PC*1/4 in what is calls Relief at Source to the Pension Plan administrator.

Unless they challenge HMRC, Higher-Rate payers don't get anything else back.

The problem here is that when a Higher-Rate payer challenges, HMRC simply refunds another PC*1/4

Thus from HMRC's POV, the full refund is PC*(1/4 + 1/4) = PC*1/2...and PC*1/2 is smaller than PC*2/3 i.e. they have kept some of the tax paid on that pension contribution.

Thus, for a £1,000 pension contribution, you get back a total of £500 instead of £666.67

Switching to a common denominator, the refund is PC*3/6 instead of PC*4/6 i.e. we're only getting 75% of the tax back!!!

So, notwithstanding the fact they don't even tell us they owe us money, when challenged, HMRC is dishonestly keeping 25% of the taxes paid. At a marginal rate of 40%, that amounts to a 10% effective tax on pension contributions.

The above is what I have personally experienced with HMRC going back to the 2019-20 tax year, and for the life of me, I'm not able to find an error in my analysis or calculations. If you can, then kindly post here, but in the meantime, I've challenged HMRC and would like to highlight this injustice to the MSE leadership to make more people aware of this situation.

artyboy

TL:DR, not my experience and I really can't pick through your mass of workings here.

In practice, as a HR tax payer, I pay 16k into a SIPP. The pension provider grosses this up to £20k. I then put this contribution on my self assessment and I get a further 4k tax rebate (ok it's always more complex than that as there are other things I may owe or be owed for).

Hey presto, 12k cost for a 20k contribution. Or 40% tax relief. And no, you don't get NI back, that's the whole reason that salsac is popular.

Sarahspangles

It’s really not a secret to higher rate taxpayers that if you contribute to a SIPP, you need to let HMRC know. Just as you do all with the other allowances and reliefs you would like to claim.

Notifying them triggers an increase in your 20% tax band to reduce your liability for HRT. Don’t understand how you can get that to anything other than a further 20%, subject to you having paid that much HRT in the first place.

Dazed_and_C0nfused

apn64 said:

TL/DR: HMRC is withholding 10% of Pension Contributions made by Higher-Rate taxpayers using after-tax income to contribute to a registered pension plan (incl. workplace pensions).
 

Not withstanding the tax-free lump sum rules, it's my understanding is that for Registered Pension Plans, HMRC taxes withdrawals and on that basis, contributions are tax-exempt.

While I realise there's not a not a lot of sympathy for Higher-Rate taxpayers, apologies if I'm the bearer of bad news, but at the present time, the bold text (above) is not always true for Higher-Rate taxpayers.

Subject to annual contribution limits, I'm aware of TWO common methods of contributing to registered pension plans (including SIPP's);

1. Salary Sacrifice
2. After-Tax Income

Either of these methods can be used for (regular) payroll deduction and occasional top-up payments to a registered pension plan.

For the avoidance of doubt, Salary Sacrifice is the most tax-efficient method of contributing to a pension plan. This is both from an Income Tax and National Insurance POV. In the latter case, you not only save NI premiums, but your employer often passes on their savings as additional pension contribution.

Unfortunately, I've discovered that contributing to a pension plan from after-tax income is fraught with problems, including right off the bat, you may not get the additional NI premiums refunded. However, I believe that I've found (and experienced) a major problem in the way that HMRC refunds taxes paid on after-tax pension contributions made by Higher-Rate taxpayers.

Unfortunately, I need to switch to some high-school algebra to explain the situation;

PC = Pension Contribution
PTI = Pre-Tax Income
TR = Tax Rate
TP = Tax Paid

1. Since we're dealing with After-Tax Income, PC = PTI - TP
2. Rearranging (1) above, TP = PTI - PC
3. Since TP = PTI*TR, we can say that PC = PTI*(1-TR)
4. Substituting PTI in (3) we get TP = PC / (1-TR) - PC, so TP = PC*(1/(1-TR) -1)

Using fractions for Tax Rate simplifies the algebra, so we'll use 1/5 for the 20% Basic Rate and 2/5 for the 40% Higher Rate.

Thus for a given Pension Contribution, the Basic-Rate payer has paid PC*(5/4 - 1) = PC * 1/4 in tax.

Similarly, the Higher-Rate payer has paid PC*(5/3-1) = PC*2/3 in tax.

From the above, we can see that for a £1,000 pension contribution, the Basic-Rate payer would have paid £250 tax and the Higher-Rate payer would have paid $666.67 tax.

i.e.  £1,250 * 20% = £1,000 in after-tax income
and £1,666.67 * 40% = £1,000 in after-tax income.


For the avoidance of doubt, the issue here is not the above, but the method used by HMRC to calculate tax refunds for Higher-Rate payers (there's NO problem for Basic-Rate payers).

Rather than refund the PC*2/3 in one-shot, HMRC provides PC*1/4 in what is calls Relief at Source to the Pension Plan administrator.

Unless they challenge HMRC, Higher-Rate payers don't get anything else back.

The problem here is that when a Higher-Rate payer challenges, HMRC simply refunds another PC*1/4

Thus from HMRC's POV, the full refund is PC*(1/4 + 1/4) = PC*1/2...and PC*1/2 is smaller than PC*2/3 i.e. they have kept some of the tax paid on that pension contribution.

Thus, for a £1,000 pension contribution, you get back a total of £500 instead of £666.67

Switching to a common denominator, the refund is PC*3/6 instead of PC*4/6 i.e. we're only getting 75% of the tax back!!!

So, notwithstanding the fact they don't even tell us they owe us money, when challenged, HMRC is dishonestly keeping 25% of the taxes paid. At a marginal rate of 40%, that amounts to a 10% effective tax on pension contributions.

The above is what I have personally experienced with HMRC going back to the 2019-20 tax year, and for the life of me, I'm not able to find an error in my analysis or calculations. If you can, then kindly post here, but in the meantime, I've challenged HMRC and would like to highlight this injustice to the MSE leadership to make more people aware of this situation.

Not enough hours in the day to correct everything that's wrong in that post.

hugheskevi

The main issue is mixing up gross and net. Extracting the key bits of the OP:

apn64 said:

i.e.  £1,250 * 20% = £1,000 in after-tax income
and £1,666.67 * 40% = £1,000 in after-tax income.

Rather than refund the PC*2/3 in one-shot, HMRC provides PC*1/4 in what is calls Relief at Source to the Pension Plan administrator.

The problem here is that when a Higher-Rate payer challenges, HMRC simply refunds another PC*1/4

Thus from HMRC's POV, the full refund is PC*(1/4 + 1/4) = PC*1/2...and PC*1/2 is smaller than PC*2/3 i.e. they have kept some of the tax paid on that pension contribution.

Thus, for a £1,000 pension contribution, you get back a total of £500 instead of £666.67

The problem here is you start with £1,666.67 of taxable earnings, which has higher rate tax applied resulting in a net  payment of £1,000 (ignoring National Insurance). But you then compare that to a £1,000 pension contribution.

If you want all of the £666.67 of income tax paid back, you need to make a pension contribution of £1,666.67. But in your figures, you instead start from the post-tax amount received of £1,000. That is grossed up by the provider to a gross contribution of £1,250 and your tax liability is reduced by £250. Hence you have made a gross contribution of £1,250 for a cost of £750. You have received a tax break of £500 on the contribution, which is equal to the higher rate tax that would be payable on £1,250 of income. Everything is correct, you have received all the higher rate relief due, but you also chose to keep £416.67 of the pre-tax payment as your pension contribution was only £1,250. After paying 40% tax on the income you chose not to put into a pension the original £1,666.67 is left as:

• £1,250 in a pension
• £250 in post tax income remaining from the original £1,666.67 pre-tax payment
• £166.67 has been paid in income tax

What you should instead be doing is starting from the gross amount of £1,666.67 to work out the pension contribution. To get that into a SIPP you would contribute £1,333.34 which is grossed up by the provider to £1,666.67 and your tax liability is reduced by £333.34. Now you have £1,666.67 in the pension at a cost to you of £1,000. You originally paid £666.67 in tax when receiving the money after tax, and have now received it back through the Relief and Source and the tax adjustment operated by HMRC.

This is a common mistake, although I have never before seen someone resort to algebra when making it 

The issue you are illustrating, if any, is that there is a bit of a cashflow management issue created by Relief at Source for higher/additional rate taxpayers, due to the need to put in some of their own money to get to the position they would be in if the contribution had been deducted prior to the operation of PAYE (known as 'Net Pay' system, which along with salary sacrifice and Relief at Source forms the 3 main contribution methods to pensions). But they can manage this by adjusting their Tax Code preemptively with HMRC in anticipation of a Relief at Source contribution later in the tax year. HMRC will code in a Relief at Source contribution of up to £10,000 for this if requested.

Marcon

apn64 said:

So, notwithstanding the fact they don't even tell us they owe us money, when challenged, HMRC is dishonestly keeping 25% of the taxes paid. At a marginal rate of 40%, that amounts to a 10% effective tax on pension contributions.

The above is what I have personally experienced with HMRC going back to the 2019-20 tax year, and for the life of me, I'm not able to find an error in my analysis or calculations. If you can, then kindly post here, but in the meantime, I've challenged HMRC and would like to highlight this injustice to the MSE leadership to make more people aware of this situation.

No - you just need to read the posts above and hopefully the penny will drop that HMRC are doing no such thing.

artyboy

hugheskevi said:

 But they can manage this by adjusting their Tax Code preemptively with HMRC in anticipation of a future Relief at Source contribution later in the tax year. HMRC will code in a contribution of up to £10,000 for this if requested.

The issue that we have found is that HMRC is actually a bit too keen to do this! In self-assessment, there is a question about whether the pension contribution is a one-off or should be expected going forward, and that is what drives them giving you forward coding relief.

For Mrs Arty and I, we have always ticked the 'one-off' box as it's been hard to predict contributions year on year, especially with carry forward coming into it. But for some reason HMrC have always assumed that we will continue to contribute at the same rate and coded us accordingly. It has led to some eye watering K codes to reclaim back taxes... fortunately we are (just about) smart enough to work out how much to plan for!

NoMore

I can’t be bothered trying to work thru that but is this another of those trying to work out tax relief based on a net contribution and therefore getting it totally wrong posts ? 

Dazed_and_C0nfused

NoMore said:

I can’t be bothered trying to work thru that but is this another of those trying to work out tax relief based on a net contribution and therefore getting it totally wrong posts ? 

Yep, same old complete misunderstanding of how pension contributions and tax relief works.

At least this time the op seems to have realised the error of their ways rather than trying to repeatedly argue their point.  To no avail of course!

Sarahspangles

Dazed_and_C0nfused said:

NoMore said:

I can’t be bothered trying to work thru that but is this another of those trying to work out tax relief based on a net contribution and therefore getting it totally wrong posts ? 

Yep, same old complete misunderstanding of how pension contributions and tax relief works.

At least this time the op seems to have realised the error of their ways rather than trying to repeatedly argue their point.  To no avail of course!

This one hasn’t accused anyone of being an IFA a as yet

Albermarle

Unfortunately, I've discovered that contributing to a pension plan from after-tax income is fraught with problems, including right off the bat, you may not get the additional NI premiums refunded. 

Not 'may' not get them back, you will 100% not get any NI refund.

Saving NI due to your employer choosing to use salary sacrifice for pension contributions, is basically a loophole. ( the employer pays less NI as well as you) 
It costs the Treasury Billions, and it seems it is on the Chancellors agenda for investigation/possible change.