Are you maximising your pension contributions with a ‘free’ top-up from the government? Think of pension tax relief as the government’s way of rewarding us for saving for the future – are you making the most of it? Here’s how.
What is pension tax relief?
When we pay into our pension, a percentage of the money that would have been paid as tax is directed into our pension instead. This reduces the amount of tax we pay and boosts our pension pot. The amount of tax relief paid depends on our tax bracket with basic-rate taxpayers receiving 20% tax relief, higher-rate taxpayers receiving 40% and additional-rate taxpayers getting 45%.
How is pension tax relief paid?
There are two ways to get pension tax relief, depending on the type of pension you have – either ‘net pay’ or ‘relief at source’.
Net pay – some workplace pensions use this calculation. Your pension contributions are deducted from your salary before income tax and your pension scheme claims the tax relief at your highest rate of income tax so you don’t need to do anything.
Relief at source – this method is used for all personal pensions and some workplace pensions. For workplace pensions, your employer takes 80% of your contribution and your pension scheme requests the additional 20% tax relief from HMRC. This system only works at the basic-rate tax level so higher-rate and additional-rate taxpayers need to submit a self assessment tax return to receive the extra 20% or 25% tax relief due.
Which way is best?
Employers get to decide which method they use. Net pay is more beneficial for taxpayers in work because no matter which tax rate you pay, you will get the full tax relief without having to claim additionally. Non-taxpayers don’t currently get tax relief via this method (though this is being reviewed by the Government) so the relief at source method is better for them. However, higher- and additional-rate taxpayers must claim their full relief directly.
Is pension tax relief limited?
Yes, there is a pensions annual allowance set at £40,000 for the tax year 2022/23. This is the most amount of contributions that you can gain tax relief on. It should be noted that for personal contributions, the limit is the lower of £40,000 and your ‘UK relevant earnings’ (basically employment income including benefits in kind, self employed income plus income from Furnished Holiday Lets). If your UK pensionable earnings are below £40,000 then your employer can still top up with employer contributions to this level. This is particularly useful to owners of small companies who may pay themselves a very modest salary for tax purposes.
Payments made above the annual allowance are subject to income tax at your highest rate. It is possible to carry forward unused allowance amounts from three years previously. There is also a lifetime allowance that means you are limited to taking £1,073,100 maximum from your pension before incurring additional charges. The £40,000 limit may be reduced if you have already accessed certain pension funds, or if your income is over £200,000. Detailed advice should be sought if you may be affected by these factors.
Tax relief for higher earners
Many higher-rate taxpayers don’t realise that they can receive 40% tax relief, but with only 20% relief given automatically, they must claim the additional 20% relief via their self assessment tax return. The figure to include must be the gross amount of pension contributions and the tax relief of 20%. The additional relief will come as an annual rebate, a reduction in your tax liability or a change to your tax code. If you realise you’ve missed out on the additional valuable tax relief, you can make a backdated claim for the previous four tax years.
For assistance with pension tax relief and all tax matters, speak to the friendly, approachable experts at CRM Oxford on 01865 379272.
