How to claim higher rate tax relief on pension contributions.

How to claim tax relief on pension contributions over the basic rate under the relief at source method

Does this mean that a £100 contribution costs £60 or even £55? Well, maybe.

With the relief at source and relief by making a claim methods, any additional tax relief is given by extending the basic rate tax band by the amount of the gross pension contribution. 

Using the above figures, for a UK taxpayer, excluding Scotland, if the full £100 falls within the earnings taxed at 40% then the whole amount will be eligible for tax relief at 40% and the net cost to them will indeed be £60. If the full £100 doesn't fall within the earnings taxed at 40%, only part of it will be eligible for tax relief at 40% and the net cost will be somewhere between £60 and £80.

An example might make this clearer. The rates used in this example are based on UK income tax rates and bands, excluding Scotland.

Helen earns £52,000. Basic rate tax applies to taxable earnings up to £37,700 and higher rate tax on the amount above this.

Her tax situation before making a pension contribution would therefore be:

• personal allowance - £12,570
• taxable income - £39,430 (£52,000 - £12,570)
• basic rate tax - £7,540 (£37,700 at 20%)
• higher rate tax - £692 (£39,430 - £37,700 at 40%)
• total tax: £8,232.

If Helen makes a gross pension contribution of £5,000 under the relief at source system, she’ll get higher rate tax relief on the part of the contribution that falls within the higher rate tax band. Helen pays higher rate tax on £1,730 of her earnings, so this is the amount on which she can claim higher rate tax relief when making a £5,000 pension contribution. As basic rate tax relief has already been applied at source, she can claim a further 20% tax relief on this amount through her self-assessment tax return. This will reduce her overall tax bill accordingly.

• tax bill - £8,232
• less £1,730 at 20% = £346
• total tax: £7,886.

The total amount of tax relief Helen has received is therefore basic rate tax relief of £1,000 (20% of £5,000) and £346 (20% of £1,730) = £1,346. This is 27% of the gross contribution, not 40%.

If Helen had made a gross contribution of £1,000, the calculation would have been:

• tax bill - £8,232
• less £1,000 at 20% = £200
• total tax: £8,032.

The total amount of tax relief Helen has received is therefore basic rate tax relief of £200 (20% of £1,000) and £200 (20% of £1,000) = £400. This is 40% of the gross contribution. This is because the contribution of £1,000 is less than £1,730 (the earnings that would have been taxed at 40% - see first calculation).

An individual will need to claim tax relief over the basic amount themselves. See Claim tax relief on your private pension payments on how to do this.

How is tax relief over the basic rate given by the net pay method?

If Helen's £5,000 contribution had been paid under the net pay arrangement, the calculations would have been as follows:

• income - £52,000
• less pension contribution - £5,000
• less personal allowance - £12,570
• taxable income - £34,430
• tax: £34,430 at 20% = £6,886

This is £1,346 less than her tax liability if no contribution had been paid (£8,232) and is therefore 27%, the same as under the relief at source system. The difference is that Helen has had her total tax relief immediately instead of having to claim her higher rate tax relief through her self-assessment tax return. If she had paid a contribution of £1,000, she would have received tax relief of 40% immediately through a similar calculation.

The rates used are based on UK income tax rates and bands, excluding Scotland. For a Scottish taxpayer the process is the same, but the tax rates and bands are different.