Additional rate taxpayers will always need to complete the self-assessment for their extra relief. On the self-assessment form there is a section on paying into registered pension schemes – it is the gross amount that should always be entered here.
For example, if your client has made a payment of £8,000 to their pension, this is a £10,000 gross contribution as the scheme will claim back £2,000 and credit it to their account. On the self-assessment £10,000 should be entered.
Once HMRC has the information, it extends the basic rate tax band by the amount of the gross pension contribution to work out the tax due for the year.
For example, a client with £80,000 of income would usually pay £19,432 of income tax – see the table below.
However, if they make a pension contribution of £32,000 net/£40,000 gross they would only pay £13,486 as their basic rate tax band has been extended by the amount of their gross contribution. This means £29,730 now falls under basic rate tax, when previously it fell in the higher rate band.
In this example, they would claim back £5,946 (£19,432 – £13,486) from HMRC. This is equivalent to 20 per cent of their earnings above the basic rate band and on top of the 20 per cent relief they have received on the whole contribution within the pension (£8,000).
No pension contribution | £40,000 pension contribution | |||
Tax rate | Tax band | Tax | Tax band | Tax |
0% | £12,570 | – | £12,570 | – |
20% | £37,700 | £7,540 | £37,700 | £7,540 |
20% extension (max £40,000) | – | – | £29,730 | £5,946 |
40% | £29,730 | £11,892 | – | – |
Total tax | £19,432 | £13,486 | ||
Sometimes it is stated that tax relief is given at the client’s marginal rate, but it is important to note that relief is only given at the rate it is paid.
In the example above, the client’s marginal rate is 40 per cent, but they do not receive 40 per cent tax relief on the whole contribution, only on the part on which they have paid 40 per cent tax – that is, the bit above the higher-rate threshold.
It is also worth noting that although the principle of tax relief on pension contributions is that you get back the tax you have paid, there is an anomaly at the lower end of the scale.
If an individual makes contributions from income that was not taxed – that is, within the personal allowance – then they still get the 20 per cent tax relief under RAS.
For example, someone with £20,000 earnings who made a £10,000 contribution would get 20 per cent tax relief on all of it – that is, they would only need to pay in £8,000 net – not just the part above the £12,570 personal allowance.
