Tax Relief on Pension Contributions
Paul Hazard APFS Chartered Financial Planner
The main advantage of saving via a Pension to get an income later in life is that you get tax relief on your contributions. The amount of relief depends on if you an employer, employee or self employed, and your tax position.
If you are employed you will normally receive basic rate tax relief on paying your contribution. Contributions paid by you are made net of basic rate tax (i.e. 20%). This means that for every £100 you want to save, you only actually pay £80. Tax relief of £20, topping your contribution up to £100, is then added by HM Revenue & Customs (HMRC).
If you are a higher rate payer (40%), you may be able to claim additional tax relief. Depending on how much you earn over the higher rate tax band threshold, any additional tax relief would range between a further 1% up to a maximum of 20%. If you’re an additional rate tax payer (50%), the relief could be up to 30%.
For example... If you are employed with an annual income of £44,000 per annum. You then pay £200 gross per month into a pension which means £160 per month net payment (20% tax relief).
£44,000 less personal allowance = £36,525 making them a higher rate tax payer. The higher rate is paid on income above £35,000. Therefore you only get the additional relief on the difference = £1,525 and not the £2,400.
If you pay tax at the higher rate, you can claim the difference through your tax return or by writing to HM Revenue & Customs. If you’re an additional rate tax payer, you will have to claim the relief via your tax return.
Self Employed or Partnership
The same method now applies to the self employed and no longer is tax deductable from your trading expenses. Some older Retirement Annuity Contracts still allow the amount to be deducted from your trading expenses (usually pre 1988 contracts).
Pension payments made by an employer can be used as a business expense against the business.
This means a director can get the company to pay contributions and save on the national insurance contributions the company would have to make.
An employee can benefit in this way by using a process known as salary sacrifice, which can be cost effective.
As an example... If the employee wanted to make a contribution of £2,400, this could be paid directly by their employer using “Salary sacrifice”. The employee agrees to have their salary reduced by the amount they want to contribute, and the contribution is paid by the employer on the employee’s behalf. Since the payment directly reduces the employees salary, both the employer and employee immediately make savings on their National Insurance contributions. The employee also saves paying income tax on the amount sacrificed. Some employers choose to further boost the pension contribution by paying the amount of National Insurance they save back into the pension plan. Whilst the salary sacrifice option is not necessarily suitable for everyone (it can reduce the amount of any state benefits or affect borrowing for mortgage purposes for example) this is an option which is well worth considering.
The annual maximum allowance is now £50,000 per annum to obtain tax relief. It is possible to claim more by carry forward any unused relief in the past three tax years. The allowance has reduced from £255,000 in the 2010/11 tax year so if you think you may be affected by the reduced allowance; do please contact us for advice.
This article was kindly provided by Mr Paul Hazard, who is also the father of a vet. Mr Hazard works for Omni-Financial Ltd:
Tel: 01582 792780
Please note that this article was first prepared for our sister site, VetGrad.co.uk in 2011 and as such some of the figures will now be slightly out of date.