If you’re a higher rate tax payer then making pension contributions can give you an instant 50% return on your investment. What other investment does that?!
Do you know if you qualify?
Find out how the 50% return works and what you need to do to ensure you get it.
How to get a 50% return on your pension contributions
When you pay money into a pension you are entitled to a refund of the Income Tax you may have already paid on the money you use to make pension contributions.
For example, if you’re an employed higher rate tax payer and you make a personal pension contribution of £800, you are deemed to have already paid 40% Income Tax on some of that £800 before you receive it into your bank account. Therefore you are entitled to that tax back. It’s called ‘tax relief.’
The basic rate Income Tax element (20%) of the refund is added to your pension contributions meaning the £800 turns into £1,000 in your pension. You are then allowed to reclaim a further 20% from HMRC direct.
This means your overall £1,000 pension contribution has only cost you £600. Or you could look at it another way and say you contributed £800 and got £400 back in tax relief. A 50% return on your money!
If you are a basic rate tax payer you are still entitled to 20% tax relief.
For an additional rate tax payer, you may be entitled to up to 45% tax relief.
Making sure your pension contributions qualify
Like all things finance related, the devil is in the detail and it requires some effort and knowledge on your part to ensure you get the most tax relief available from your pension contributions.
#1 – Personal pension contributions vs employer contributions
Understanding how your pension contributions are made is crucial.
For many people most of their pension contributions will be directed into their workplace pension scheme, and their employer will handle all of this.
There are two ways your employer could make the pension contributions:
- ‘Net pay’ – Also known as salary sacrifice, means your employer will deduct your pension contribution from your salary before you are taxed meaning you get the full benefit of tax relief right at the start and there is nothing further to do.
- Relief at source – Your employer will deduct your pension contribution after you have been taxed. Therefore your pension contribution will be topped up inside the pension (basic rate relief) and if you are a higher rate tax payer you will need to claim the higher rate relief from HMRC.
You must contact your HR department to find out which method is used by your employer so as not to miss out on ALL your tax relief.
You do not receive personal tax relief on employer related contributions.
#2 – You must claim the higher rate relief
As mentioned above, if your employer operates the ‘relief at source’ method when making pension contributions or you have your own private pension which you pay into, then you won’t automatically get the higher rate tax relief.
If you leave it without doing anything you will be missing out on the additional 25% return you are entitled to.
To claim you must either contact HMRC and they will pay you direct or ensure you have listed all of your pension contributions in the right way on your Self Assessment Tax Return.
#3 – Annual Allowance
There is a limit on how much tax relief you can get and it is controlled by the ‘Annual Allowance’.
Currently the most you can pay into all pensions (combined) in any one tax year is the lower of £40,000 or 100% of your earnings.
There are a few additional factors that may reduce your Annual Allowance:
- If your threshold income is over £200,000 your Annual Allowance will reduce. This is called the ‘Tapered Annual Allowance’.
- If you have accessed a defined contribution (money purchase) pension on a flexible basis and have taken income then your Annual Allowance will be reduced to £4,000. This is called the Money Purchase Annual Allowance.
Again it is your responsibility to monitor your allowance. Your pension company or employer won’t do it for you.
Don’t get caught out by your employer making a pension contribution on your behalf taking you over the allowance because they did not know you had already made a personal contribution to a private pension.
#4 – You don’t have to contribute from earnings
Whilst the rules state that you must have ‘earnings’ to be able to make pension contributions above £2,880 per year you don’t actually have to make the contribution from your salary.
For example, you could be paid by your employer and pay nothing into a workplace pension. You could still make a personal pension contribution from your savings providing it is within your Annual Allowance (see point 3 above).
#5 – You only get tax relief on contributions
Tax relief only applies on the pension contributions you make it doesn’t apply to all of your income.
For example, if your salary is £100,000 per annum and you make an £800 pension contribution, you are only entitled to £400 in tax relief. Not a refund of all tax paid on all income at a higher rate.
How have your investment returns been over the last 3-6 months? Are you benefiting from a 50% return on your pension contributions?
If you would like to understand what level of pension contributions you should be making in order to retire when you want please secure a free 15-minute call with us. You can speak to a Chartered Financial Planner who will listen to your situation, give you an outline of what you need to consider and guide you in the right direction.
Don’t miss out on what’s yours.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.