Help understanding Tax Free allowance

WorthIt · 22 July 2018 at 3:05PM

Hi, apologies in advance if this has been answered already in the forum - couldn't find it.

I had a couple of questions about the tax free allowance:
1) Let's say that someone is auto enrolled in their work pension plan and countributes some additional amount through salary sacrifice.
Let's say that his tax free allowance is 10k, and his monthly (pre tax) salary sacrifice is 1k, and say his employer contribution is 0.5k a month.
How do the taxes work then? Is it
A) His salary sacrifice is still tax free, and any allowance limit is only on any additional pension contribution (ie SIPP etc) OR

He is automatically taxed on 2k (12k salary sacrifice - 10k allowance) by the pension plan guys and he doesn't have to do anything during self assessment. OR
C) The pension plan already claims 20% tax rebate on the 12k salary sacrifice and if he is at 40% tax rate, he has to pay back something to HMRC? (And how much?)
D) Any other?

2) If this person then decided to open a simple SIPP and invests 10k in an year there, how does the tax work then? Since he has already paid tax on the amount before getting the money, he wouldn't have to pay any further tax on it, but can the pension contribution lower his tax code?

jamesd · 22 July 2018 at 4:31PM

Salary sacrifice is done by making employer contributions with the employee getting less pay. The tax is never deducted and employer contributions don't get any tax relief added, you get that by not having the tax deducted. The pension plan claims nothing from HMRC for the salary sacrifice money.

You appear to be using tax free to refer to the no taxing of salary sacrifice money before it goes into a pension. The normal annual allowance for this is 40k per year but carry-forward of unused allowance from the past three years is allowed. In addition, an employer is not allowed to pay less than minimum wage. The 40k applies to all contributions into pensions in your name by anyone.

HMRC doesn't need to be told about salary sacrifice unless you go over the annual allowance and any available carry-forward. They get the taxable pay information and that's all they need.

In addition to salary sacrifice you can make pension contributions to a SIPP or any other type of pension. The gross amount arriving in the pension is subject to two limits and the lowest one applies:
1. your gross pay after salary sacrifice.
2. the amount of the 40k annual allowance plus any available carry-forward.
You do need to tell HMRC the gross value of these contributions if your after sacrifice gross pay is above the higher rate income tax threshold, so they can arrange to give you the extra higher rate tax relief, usually by adjusting your tax code.

londoninvestor · 22 July 2018 at 5:05PM

NoMore wrote: »

I'm not sure what this tax free allowance of 10k is ? Do you mean the 0% income tax band, currently £11850.

Possibly the OP is referring to the £10k Annual Allowance for pension contributions that a > £210k earner would have?

WorthIt · 22 July 2018 at 5:10PM

Thank you London Investor, I was referring to exactly this case.

londoninvestor · 22 July 2018 at 5:14PM

WorthIt wrote: »

Thank you London Investor, I was referring to exactly this case.

Thanks, what jamesd says matches my understanding then - as long as you substitute 40k with 10k. You'll need to deal directly with HMRC to handle the tax due on the part of the contribution that exceeds the allowance.

Do remember that as jamesd says, you might have unused allowance from prior years which you might be able to carry forward...and that allowance might be greater than 10k per year (if you earned less than 210k in those prior years).

WorthIt · 22 July 2018 at 5:27PM

Thank you JamesD and London Investor.

Had tried, but couldn't make much sense from HMRC website about what happens in this case, will have to hope no surprises come up during self assessment time.

Help understanding Tax Free allowance

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