Tax relief on pension contribution – am I over analysing?

[Air Support]

Hi all

I’ve tried googling this topic and as yet I haven’t had time to spend an hour on the phone holding for HMRC….

So I’m hoping one of the experts or experienced investors on here might be able to answer this one.

I have both earned and unearned income and want to contribute to a personal pension this year.
I know that only my earned income counts for tax relief for pension contributions but my concern is whether the tax relief available is limited to the tax I’ve paid against the earned income and if so how this tax is calculated i.e. is earned income assumed to be taxed first for pension contribution relief purposes then remaining tax taken on unearned income? This would reduce the amount of tax relief vs unearned income assumed first and earned income second.

Or is it simply that I am able to claim tax relief against the full value of my earned income (up to the £40k annual limit) and if so what rate would apply – 20% or the full 40% if my total income takes me into the higher rate tax band? Or even more simply, this contribution is discounted against my annual income and no longer subject to tax at all?

If anyone is able to explain exactly how this situation would work I’d really appreciate it.

Thanks

[oldaudi]

Great post and any answers may help me. I pay AVCs on my work pension. I never know if how they're taxed! Madness I know. Does a £100 only cost me 60£ at 40% or £100 costs £100. My internal HR dept don't know and I confuse the pension provider when I try to explai it

[CoolHands]

An expert may be along in a minute, but oldaudi I believe if you are a higher rate tax payer, and are paying £100 into pension as shown on your pay packet before deductions, £100 is being paid into your pension pot. But if you hadn't put it into the pension, and taken it in wages, you would only actually receive £60 to take home (because you'd pay 40% tax). In this way the tax relief is seen as an advantage as the benefit of £100 you get in your pension only effectively 'cost' you £60 difference in your take home pay.

[oop north]

Not completely sure about this or exactly what is being asked. However, the max pension contribution you can pay is 100% of your earnings (which include employer pension contributions). The tax relief you can get is restricted to tax payable on all earnings. But if your income is part dividends then the tax credit (which disappears from April) doesn't count

So there are a couple of things going on - and depending on your situation (which the op has been coy about) then there could be more

With respect to how much relief on contributions - a 40% taxpayer will get full relief at source at 40% if done as salary sacrifice (and save the 2% NIC also). If done as personal contribution out of post tax pay, the contribution paid is net of 20% basic relief and do the difference between 20% and 40% will be obtained through tax return / tax code etc

[Ozzie Osmond]

1. Tax relief is at your highest rate, whatever the income source.

2. Tax relief runs out at the limit of your earnings (although everyone can do a contribution of £2,880 which the government will top up to £3,600, which is useful to use for a non-working partner if you have spare cash. Or the kids.)

3. Tax relief on money purchase contributions is essentially limited to £40,000 of contributions p.a.

https://www.moneyadviceservice.org.uk/en/articles/...

[Air Support]

So to try to explain more clearly.

I have a pension income from my previous employer plus earned income from a different employer.
My proposed pension contribution will be less than my earned income and under the £40k annual limit, so all good there. However I'm worrying (maybe unnecessarily) that my pension relief may also be limited to the TAX paid against earned income. I don't know if this is actually a real consideration and haven't found a way to check the position.

So if this is a real constraint (and not just one I'm imagining) then the question becomes one of how does HMRC view the order of your income for pension contribution tax relief. Obviously the pension doesn't count as earnings.
Hence if your income takes you into the higher rate band then the tax against earned income is different depending on how HMRC calculates your tax bill for relief purposes from the following two possible ways:

1) Deducts personal allowance from total income then calculates tax on earned income then works out remaining tax due on pension income. Earned income tax figure = £X
or
2) Deducts personal allowance from income then works out tax on pension then earned income. Earned income tax bill= >>£x
So that I hope describes my concern but as I say, I just don't know how it works or if I'm OK simply if the pension contribution is < earned income and <£40k

[Ozzie Osmond]

Air Support said:

I have a pension income from my previous employer plus earned income from a different employer.
My proposed pension contribution will be less than my earned income and under the £40k annual limit, so all good there.

Check the link I posted above. You may well be limited to £10,000 p.a. because you are already drawing a pension.

TBH your question is rather beyond an internet forum.

[Air Support]

My pension is from an employer's scheme and I'm contributing into a flexible drawdown scheme.
I had it confirmed that as long as I'm not drawing down on the new scheme I retain the £40k annual allowance so should be fine. So this aspect isn't an issue.
Just left with my worry that HMRC might limit your contribution so that tax saved doesn't exceed that paid against earned income.

[JulianPH]

Air Support;

I think there is some general confusion going on here.

(1) You are talking about investing earned income only. This, by definition, would otherwise be subject to income tax.

(2) If you place this into a pension it is no longer subject to income tax (unless you withdraw it as income in the future).

(3) Therefore it is not possible for you to ever get back more tax relief that you would have otherwise paid in income tax.

Does that help - or am I missing the point..!