Member contributions and higher rate tax relief

We've seen in the Member contributions - tax relief and annual allowance article there are various methods of giving tax relief on member pension contributions but how is higher-rate or additional rate tax relief given?
Key facts

Higher and additional rate tax relief:

  • needs to be claimed if the scheme uses either relief at source or relief by making a claim methods
  • is normally claimed through the individual’s self-assessment tax return
  • is granted by expanding the basic rate band

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, higher rate tax relief is given by extending the basic rate tax band by the amount of the gross pension contribution. Using the above figures, if the £100 isn't greater than 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 £100 is greater than 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 in 2019/20. Basic rate tax applies to taxable earnings up to £37,500 and higher rate tax on the amount above this.

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

  • Personal allowance - £12,500
  • Taxable income - £39,500 (£52,000 - £12,500)
  • Basic rate tax - £7,500 (£37,500 at 20%)
  • Higher rate tax - £800 (£39,500 - £37,500 at 40%)
  • Total tax: £8,300

If Helen made 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 lies in the higher rate tax band. She pays higher rate tax on £2,000 of her earnings, so that's the amount on which she'll get higher rate tax relief if she makes a £5,000 pension contribution. She's already getting basic rate tax relief at source, so she'll get another 20% of tax relief on the contribution. Her tax bill will be reduced by this amount.

  • Tax bill - £8,300
  • Less £2,000 at 20% = £400
  • Total tax: £7,900

The total amount of tax relief Helen has received is therefore basic rate tax relief of £1,000 (20% of £5,000) and £400 (20% of £2,000) = £1,400. This is 28% of the gross contribution, not 40%.

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

  • Tax bill - £8,300
  • Less £1,000 at 20% = £200
  • Total tax: £8,100

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 £2,000 (the earnings that would have been taxed at 40% - see first calculation).

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 - £12,500
  • Taxable income - £34,500
  • Tax: £34,500 at 20% = £6,900

This is £1,400 less than her tax liability if no contribution had been paid (£8,300) and is therefore 28%, 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 self-assessment. If she had paid a contribution of £1,000 she would have received tax relief of 40% immediately through a similar calculation.

PTM044000: tax relief for members: contents

Notes

The rates used are based on UK income tax rates and bands, excluding Scotland.

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.

All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.

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Last updated: 14 May 2019

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