Tax Insider Tip: Pension Funding

Payments into an approved pension scheme attract tax relief at your highest rate of tax and are deemed to be paid net of basic rate tax.

For 2014/15 the annual limit on tax-relieved pension savings is set at £40,000 (reduced from £50,000 for 2013/14). Relief for contributions up to the limit is given at the taxpayer’s marginal rate of tax, meaning that pension contributions are tax-effective, especially for higher and additional rate taxpayers.

It is also possible to carry forward unused allowances from the previous three tax years which means that it is possible to make significant tax-relieved contributions to a registered pension scheme.

A basic rate taxpayer will effectively pay £80 for a £100 contribution into a registered pension scheme. For higher rate taxpayers, a £100 pension contribution costs £60 and for additional rate taxpayers, the cost is just £55. This makes pension savings particularly tax-efficient.

Example:
John invests £2,000 into his pension scheme, which costs him £1,600 as this is paid net of basic rate tax, which the pension fund recovers bringing the pension contribution to £2,000.

As a higher rate taxpayer paying tax at 40% he claims higher rate tax relief on this and receives a tax rebate of £400 (being the difference between the higher rate relief due of £800 and the basic rate relief already given of £400 (i.e. 20% of £2,000)) from HMRC.

Jack is an additional rate taxpayer paying tax at 45%. He too invests £2,000 into his pension scheme, which costs him £1,600 as this is paid net of basic rate tax.

As an additional rate taxpayer he can claim further tax relief of £500 from HMRC, which he receives as a tax rebate. This is 25% of £2,000, being the difference between the basic rate (20%) and the additional rate of 45%.