understanding pensions tax relief
Saving for retirement can be a daunting task. We all know we must do it, probably your employer has already started doing it on your behalf, but is it enough? What is enough, actually? These are all very valid questions and there is a plethora of “rules of thumb” available and a very large industry of advisers that constantly advise you that you should be making plans towards your retirement. It is unfortunate that majority of advisers use complicated jargon (I think sometimes they have no choice really, I have been there) in an effort to educate their clients. Hopefully, the next few paragraphs will give you an idea of how tax relief for pensions work and how you can take advantage of these to save for retirement.
let the government help you save for retirement
Yes, really they can, and have been all these years. Let’s use an example to demonstrate this;
Susan has a goal to contribute £100 to her pension this month. Claire earns below the basic rate tax band of £46,350 per year. Susan only has to contribute £80 towards her pension of her £100 goal. Why? Because the government has provided tax relief of 20% that essentially grosses up her £80 by £20 to £100. Her £100 is what is known as a gross contribution and the £80 is known as her net contribution. In reality how this works is that the tax relief is reclaimed by your pension provider.
Susan’s Monthly goal: Basic rate taxpayer | £100 |
|
Tax relief claimed by her pension provider | £20 | 20% * £100 |
Susan only has to contribute | £80 | 80% * £100 |
This means that if Susan continues to contribute this amount of £80 per month, she will have accumulated a pension valued at £1,200 when she only actually contributed £960. The difference(£240) is grossed up with the help of tax relief. | ||
Let’s look at John who earns between £46,351 and £150,000 per annum. He is a higher rate taxpayer. In addition to the 20% gross up, he also gets additional tax relief of 20%, giving him a total of 40% tax relief! This means that if he wishes to contribute £100 towards his retirement this month, he only has to contribute £60 and the government will automatically gross up his contribution by 40% (£40) to £100. In reality how this works is that your pension provider will reclaim the tax relief up to 20%, and you will be entitled to claim an additional tax relief of 20% in your self-assessment return, giving you the full 40% relief.
John’s Monthly goal: Higher rate taxpayer | £100 |
|
Tax relief claimed by his pension provider | £20 | 20% * £100 |
Tax relief John can claim on his self assessment | £20 | 20% * £100 |
John only has to contribute | £60 | 60% * £100 or (£100 – £20- £20) |
This means that if John continues to contribute this amount of £60 per month, he would have accumulated a pension valued at £1,200 when he only actually contributed £720. The difference(£480) is grossed up with the help of tax relief. | ||
Now, here is Janet who earns above £150,000 per annum. For tax purposes she is considered an additional rate tax payer. For additional rate tax payers, they get additional tax relief of 25%, in addition to the already available standard 20% that Susan gets, giving her total tax relief of 45%. This is claimed in the exact same way as John above. If she wants to also contribute £100 this months, she only actually has to contribute £55. Here’s how that works out;
Janet’s Monthly goal | £100 |
|
Tax relief claimed by her pension provider | £20 | 20% * £100 |
Tax relief John can claim on his self assessment | £25 | 25% * £100 |
John only has to contribute | £55 | 55% * £100 or (£100 – £20- £25) |
This means that if John continues to contribute this amount of £55 per month,she would have accumulated a pension valued at £1,200 when he only actually contributed £660. The difference(£540) is grossed up with the help of tax relief. | ||
