Tax relief on contributions
Tax relief is one of the biggest incentives for contributing to a pension.
It can provide a welcome boost to your retirement savings, particularly if you’re a higher or additional rate taxpayer, so you should try to use your allowances in full where possible.
Don’t forget, though, tax rules are subject to change, and the value of tax benefits to you will depend on your personal circumstances.
Let’s explore what’s on offer.
Tax relief and allowances
The level of tax relief available depends on the individual plan holder’s tax status. The examples below assume that the contributions fall within both the Annual Allowance and the Lifetime Allowance, and that no taxable income has been drawn through Flexi-Access Drawdown (FAD) or Uncrystallised Funds Pension Lump Sum (UFPLS). You can pay in up to £40,000 or 100% of earnings (whichever is the lower amount) and receive tax relief for 2015/16.
One important thing to bear in mind is that the amount of tax relief is based on what’s known as the grossed-up amount. This is the amount of money you’d have paid in if basic rate tax had not been deducted. So if £80 is paid in, the grossed-up contribution would be £100.
Basic rate taxpayers
If you pay basic rate income tax – 20% in 2015/16 – your pension provider will claim back 20% of the grossed up contribution from HMRC for each pound you contribute to your scheme. This means that for every £80 you pay in, you end up with £100 in your pension fund.
You can only claim tax relief if you paid income tax on earnings that match or exceed the gross contribution (your contribution + tax relief) in the same tax year. So if you paid in £12,000 and you want to claim 20% tax relief (on the grossed-up amount, which works out as £3,000) to boost your contribution to £15,000, you must have earned and paid income tax on at least £15,000. This would usually mean that your income would need to be at least £25,600 (in view of the £10,600 personal allowance).
Higher rate taxpayers
If you paid higher rate income tax – 40% in 2015/16 – on at least the amount you paid into your pension, you can claim a further 20% tax relief on top of the 20% basic rate tax relief. This means a £100 contribution (£80 paid in and £20 claimed by your provider and added to your pension) would only cost you £60. However, you’ll need to make a claim, through your self- assessment tax return, if your contributions are not made through your company payroll.
The same rules apply about earning and paying tax on at least the same amount as the gross contribution.
If you’re in an employer’s pension scheme you probably don’t need to actively claim the tax relief. It’s normally all done for you because the money you pay into your pension is paid in before tax is deducted. This means that you get the benefit of tax relief at your highest rate of tax automatically. If you’re not in a company scheme your pension provider should still claim 20% back from HMRC.
Additional rate taxpayers
If you pay additional rate income tax (45% in 2015/16), you can claim further tax relief for any money you put into your pension.
Your pension provider will claim 20% back from HMRC as above, giving you £100 in your pension fund for every £80 you pay.
You’ll need to claim back the balance of your tax relief through your self assessment tax return. So the additional relief would come back to you as a tax offset or a rebate, which means that you could end up with £100 in your pension fund at a cost to you of only £55, after a total of £45 in tax relief.
A company scheme, again, it’s all done automatically for you.
Reductions in the amount that you can receive tax relief on
The July 2015 Budget announced changes to these rules from April 2016. If your taxable earnings and pension contributions – both yours and those from your employer - exceed £150,000, the amount that you can pay into pensions and receive tax relief on will start to reduce. For each £2 that your “adjusted “income exceed this £150,000 threshold your Annual Allowance reduces by £1 for every £2 until it reaches £10,000. Those earning over £110,000 should consider whether they wish to take full advantage of the £40,000 allowance available to them in the 2015/16 tax year before this change comes into effect.
Even if you don’t pay tax, you’re still entitled to receive basic rate tax relief on pension contributions. In this way, a pension’s actually a rare opportunity to gain something for nothing. Students, children and stay-at-home parents who don’t pay tax could all benefit from this.
The tax relief works in the same way as for basic rate taxpayers – so for every £80 you pay in, you end up with £100 in your pension fund. As a non-taxpayer the maximum you can pay into your pension is £2,880 a year, which is equivalent to a £3,600 contribution when you add in the tax relief claimed back.
Contributing for someone else
Anyone can contribute to a pension.
If you do this for your partner, child, grandchild or anyone else, they’ll get basic rate tax relief of 20% added. And this won’t affect your own contributions or allowances.
If you’re a higher or additional rate taxpayer, you can’t claim any further tax relief through your self- assessment tax return, though– it's just the basic rate relief that applies.
If the plan holder you’re contributing for is a higher or additional rate taxpayer, they will be able to claim additional relief through their own self-assessment.
Here’s an example:
A higher-rate (40%) taxpayer pays £800 into his partner's pension. The partner is a non-taxpayer. The pension will claim 20% basic tax relief from HMRC – that’s a further £200. Because the plan holder isn’t a higher rate taxpayer, no other tax relief can be claimed.
Company or occupational pension plans
Under Auto Enrolment, all companies must offer employees a pension scheme by 2018. You can choose to opt out, although this may be unwise if your employer is matching your contributions. The minimum total contribution is currently 2% although it will increase to 4% in October 2017 and 8% in October 2018.
With these schemes, you receive direct tax relief on the money you pay in. This is because your employer takes the pension contributions from your pay before deducting tax and pays it into your pension scheme or fund. So you don’t pay tax on this part of your salary, and your pension gains the tax relief immediately.
Tax rules can change and the benefits and drawbacks of particular tax treatments will vary with individual circumstances. Barclays Stockbrokers does not provide financial or tax advice. If you are unsure you should seek independent professional advice.
- Tax rules can change and the benefits and drawbacks of particular tax treatments will vary With individual circumstances.
- SIPPs are not for everyone. You need to have the necessary skills to invest your own pension fund as the value of investments can fluctuate and you could get back less than you invested.
- Barclays Stockbrokers does not provide financial or tax advice, if you are unsure please seek independent advice.