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 due 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, 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 lies in the higher rate tax band. She pays higher rate tax on £1,730 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 through her self-assessment tax return. Her tax bill will be reduced by this amount.
- 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. They can do this using their self-assessment tax return or by calling or writing to HMRC.
