Tax relief on pension contributions for higher rate tax payers.

Warriors1979

Sorry, this is long, but I hope clear, and that someone who knows enough about this stuff will be inclined to read through (or will just know straight away the issue I'm talking about). 

I feel I am going slightly mad trying to get the right tax relief on my pension contributions.

I'll try to lay this out as clearly as possible: 

1) As I understand, all pension contributions are income tax-free (up to £60k a year, with other caveats)

2) I have what I believe is called a 'relief at source' pension. All my income is taxed, and whatever I contribute, is then topped up by my pension provider with the default 20% tax relief. 

3) My contributions for the tax year 24/25, of £4,680.62, would have all been taxed at 40%. I.e. the actual pre-tax pay I received before making these contributions was: £4,680.62 / 0.6 = £7,801.03. 

4) So the total tax paid (and therefore, tax relief due) is £7,801.03 - £4,680.62 = £3,120.41

5) The actual tax relief I have received via my pension provider, through the automatic 20% relief, is £1,170.16. A complexity here is that the automatic 20% relief does not differentiate between whether the contribution made has been taxed at 20% or 40%. For illustration: 

a) If someone is taxed at 20% on £100 earned and pays £80 in to their pension, they get £20 tax relief paid in.

b)  If someone is taxed at 40% on £100 earned and pays £60 in to their  pension, they get £15 tax relief paid in (in spite of the fact that the equivalent deduction from their salary at the 20% threshold is £20).

6) This is understandable - my pension provider is not going to know what rate of tax I pay. But I had assumed that when I completed a tax return with HMRC, this issue would be accounted for, and that the additional 20% tax relief would be applied, resulting in me having paid no income tax on these contributions. 

7) Instead, I have run through my tax return (having input my personal contributions and the amount this has been topped up by in tax relief already, per the HMRC guidelines), and HMRC calculates the amount due to me as £1,170.20 (i.e. almost identical to the amount of tax relief I have already received). I assume that to have reached this figure - taking my £100 example above - they have looked at a £60 contribution, which has already had a  20% relief (£15) applied on it, and then added another 20% relief on £60, resulting in a total tax relief of £30. 

8) So I think this discrepancy happens because of applying a 'flat' 20% rate relief on 80% of a pre-tax income and 60% of a pre-tax income. 

Have I fundamentally misunderstood something? I'm surprised this seems to be such an obscure issue and that I can only find a handful of references to this elsewhere online - none of which seem to really give a clear resolution. 

I've asked ChatGPT (of course) for its view on this. It explains that while my above logic is correct, the issue is that HMRC takes a "grossed-up" approach to calculating relief - i.e. it applies 20% relief on you contribution and then 20%, just as I have shown above. However, the source it provides for that from HMRC does not really state this, it just gives an example where a higher rate tax payer that contributes £800 gets £200 initial relief, and then another £200 by applying for the further relief. But to me, this still just looks like an erroneous approach, rather than intended policy, especially as pension contributions are tax-free (again, within certain limits). Further, if I was instead part of a pension scheme where pension contributions were made pre-tax, then I would be able to make contributions tax-free.

Can anyone help? Am I just wrong? Or is this just error or purposeful policy on the part of HMRC? Thanks if you've managed to read through this whole thing and have an answer!   

Sarahspangles

If you’re a higher rate taxpayer you need to follow the HMRC process to claim relief not given at source I.e the difference between the 40% tax you paid and 20% you got in relief. It’s paid to you, not into the pension.

Details here https://www.gov.uk/guidance/claim-tax-relief-on-your-private-pension-payments

The mechanism used is to increase your 20% band so in-year this can be done through your notice of coding. That’s assuming you’re PAYE and don’t submit a Self Assessment Return. After the end of the tax year it goes into the P800 process. If your personal savings allowance was reduced that will be reinstated so long as you pay enough into your pension for all your income to be in the 20% band.

Dazed_and_C0nfused

Relief at source pension contributions only ever benefit from basic rate (20%) tax relief.

Your net contribution, say £200, has 25% added by the pension company (courtesy of HMRC) giving you a gross contribution of £250.  The £50 added in tax relief is 20% of the gross contribution.

There is no other option, that is how it works whether you are a non taxpayer, basic rate or pay the Scottish 48%.

The gross contribution does however increase your basic rate band and this will mean, if you are due higher rate relief on the whole contribution, you pay more 20% tax and less 40% tax.  So for some people this will mean an additional saving, equal to 20% of the gross contribution.

There are fairly regular posts about this where people don't accept this for several pages of back and forth.  Then they realise it is how things work and do finally accept they have misunderstood how pension tax relief works.

molerat

Pay in £60.  Provider adds 25%, £15, making £75 gross into pension.  Additional 20% tax refunded on £75 is £15, £60- £15 = £45.

If you paid £75 into your pension as net pay you would save £30 tax, cost to you £45

Both scenarios put £75 into pension for £45 cost.

hugheskevi

What you think you have done:

• Made a gross contribution of £7,801.03
• of which basic rate relief was £1,170.16
• and you got a tax refund of £1,170.20
• Resulting in a net cost of £5,460.67

What you have actually done:

• Made a net contribution of £4,680.62
• This receives basic rate relief from the pension provider, resulting in a gross contribution of £5,850.78
• You receive a tax refund of £1,170.16
• Taking account of the tax refund, you have contributed £3,510.47 and got £5,850.78 in your pension

Once you realise you have made a gross contribution of £5,850.78 and not £7,801.03, everything will make sense. If you wanted a gross contribution of £7,801.03 you would make a net contribution of £6,204.82 and receive a tax refund based on that amount.

dunstonh

I've asked ChatGPT (of course) for its view on this. It explains that while my above logic is correct, the issue is that HMRC takes a "grossed-up" approach to calculating relief - i.e. it applies 20% relief on you contribution and then 20%, just as I have shown above. 

Pension contributions are gross.     What you pay (i.e. bank transfer, direct debit etc) may be net of basic rate tax but the contribution is gross.   Tax relief is not added on.   It is a reduction on the gross contribution.  There is then an additional step for higher rate relief.

When considering how much you pay, start with the gross amount and work backwards from there.

So, hugheskevi's explanation and the others above appear to be the most likely outcome.

Warriors1979

hugheskevi said:

What you think you have done:

• Made a gross contribution of £7,801.03
• of which basic rate relief was £1,170.16
• and you got a tax refund of £1,170.20
• Resulting in a net cost of £5,460.67

What you have actually done:

• Made a net contribution of £4,680.62
• This receives basic rate relief from the pension provider, resulting in a gross contribution of £5,850.78
• You receive a tax refund of £1,170.16
• Taking account of the tax refund, you have contributed £3,510.47 and got £5,850.78 in your pension

Once you realise you have made a gross contribution of £5,850.78 and not £7,801.03, everything will make sense. If you wanted a gross contribution of £7,801.03 you would make a net contribution of £6,204.82 and receive a tax refund based on that amount.

This is such a helpful explanation (as is everyone else's on this thread)! Thank you. I had obviously been thinking about this in completely the wrong way. 

Albermarle

Warriors1979 said:

hugheskevi said:

What you think you have done:

• Made a gross contribution of £7,801.03
• of which basic rate relief was £1,170.16
• and you got a tax refund of £1,170.20
• Resulting in a net cost of £5,460.67

What you have actually done:

• Made a net contribution of £4,680.62
• This receives basic rate relief from the pension provider, resulting in a gross contribution of £5,850.78
• You receive a tax refund of £1,170.16
• Taking account of the tax refund, you have contributed £3,510.47 and got £5,850.78 in your pension

Once you realise you have made a gross contribution of £5,850.78 and not £7,801.03, everything will make sense. If you wanted a gross contribution of £7,801.03 you would make a net contribution of £6,204.82 and receive a tax refund based on that amount.

This is such a helpful explanation (as is everyone else's on this thread)! Thank you. I had obviously been thinking about this in completely the wrong way. 

Don't worry, many of us have had the same misunderstanding in the past !