Pension relief on higher rate band earners

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Hi,

I came across this question on personal pension contribution relief.

Taxable income: £87500

Previous years' gross personal pension contribution: £6000/year

consider to make the maximum possible amount of additional gross personal pension contribution for the tax year, but only to the extent that the contribution will attract tax relief at the higher rate of income tax.

The question: advise the amount of additional gross personal pension contribution one can make for the tax year which will benefit from tax relief at the higher rate of income tax, and explain why this is a tax efficient approach to pension saving.

The provided solution:

For 2019/20, £(87500-(37500+6000))=£44,000 of one's income is currently taxable at the higher rate of income tax.

This is less than the available annual allowaces of £(40,000*4-6,000*4)=£136,000 for 2019/20.

Resstricting the amount of personal pension contributions to the amount qualifying for tax relief at the higher rate will minimise the cost of pension saving because each £100 saved will effectively only cost £60 (£100 less 40% tax relief).

My two questions:

1. Is the amount of pension pension contribution that qualifying for tax relief at the higher rate: £44,000?

2. What does it mean by each £100 saved will effectively only cost £60 (£100 less 40% tax relief)? I don't understand the rationale behind the calculation.

--Follow up--

I seem to have caused up a lot of heat and even attracted an AWEB team moderator to contact me directly for being impolite.

I feel I have to make a few clarifications. And I would apologise in advance to anyone if my follow apologisation even causes more grievances:

1. Re dismissive tone. I am not sure which part of follow-up question is perceived as dismissive? But I suspect the dismissve perception might have come out of the taxable income clarification I made in the replying threads (re the 12500 PA deduction against the £100,000 total income figure). But I feel I had to clarify, cause I was being accused of asking questions by not giving the entire picture or even copying wrong information. But the PA is irrelevant here, so changed the question to give a more concise summary without losing key information, else the question looks long.

2. Re impolite for not giving appreciation in Matrix spending time and giving explanation. I'll admit I failed to thank him before his callout. In ramification, I clicked the "Thank you" upvote button not only to his explanation thread, but also to Gainsborough who make the clarification that the question comes from a revision kit. Perhaps "Thank you" upvote button isn't enough. I will bear in mind and give appreciation in full reply to anyone who does help in future, but not to those who make snarky comment but help.

3. The only thing I think I may have caused offense is perhaps come from the reply containing "Nevermind ...". In doing so, I sincerely apologise to Matrix.

I hope my follow-up commentary above satisfies every stakeholder who's interested in this unfortunate playout.

Replies (27)

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By Matrix
27th Jun 2020 11:38

1. You need to redo your calculation by adding the personal allowance. Wouldn’t higher rate tax only be payable above £56,000?

2. If someone has paid tax at 40% then they get it back so for every £60 they put in they end up with £100.

I don’t know why the question assumes that it would be inefficient for a basic rate taxpayer to make contributions, you still get 20% tax relief. You don’t get higher rate tax relief since you haven’t paid higher rate tax.

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Replying to Matrix:
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By lukayl
27th Jun 2020 14:01

Matrix wrote:

1. You need to redo your calculation by adding the personal allowance. Wouldn’t higher rate tax only be payable above £56,000?

2. If someone has paid tax at 40% then they get it back so for every £60 they put in they end up with £100.

I don’t know why the question assumes that it would be inefficient for a basic rate taxpayer to make contributions, you still get 20% tax relief. You don’t get higher rate tax relief since you haven’t paid higher rate tax.


1. The tax year is 2019/2o for FA 2019, so the higher rate band is 37500.
2. Sorry, I still don't understand.
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Replying to lukayl:
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By SXGuy
28th Jun 2020 09:46

No no. 37500 + 12500 PA. You pay 40% after the first 50000

Up to 12500 0%
12501 - 37500 20%
37501 - 40%.

You would benefit from looking at the tax rates and thesholds.

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Replying to SXGuy:
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By gillybean04
28th Jun 2020 12:05

SXGuy wrote:

No no. 37500 + 12500 PA. You pay 40% after the first 50000

Up to 12500 0%
12501 - 37500 20%
37501 - 40%.

You would benefit from looking at the tax rates and thesholds.

You might want to check your numbers there.

Thanks (2)
Scooby
By gainsborough
27th Jun 2020 12:01

Hi both. I teach ACCA TX, so have the benefit of seeing the whole question (which was updated from the 2016 exam).

Matrix - I think they found a lot of students were struggling to identify higher rate tax saved on pension contributions, so worded the question differently and doesn't really match what we might advise in real life.

So. yes to both your questions lukayl. Taxable income after PA is £87,500 (trade £100K-£12500). Your new basic rate band stretched is £43,500, so this leaves £44,000 taxed at the higher rate.

Matrix has already answered your second question (20% relief at source and another 20% relief given via stretching the bands).

Are you studying for this exam with a college? If so, would really recommend that you also seek help from your tutor.

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Replying to gainsborough:
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By Matrix
27th Jun 2020 12:07

Thanks. Well it would be helpful for students to put the whole of the question up in future. It says the taxable income is £87.5k and not £100k.

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Replying to Matrix:
Scooby
By gainsborough
27th Jun 2020 13:21

Exactly. I think a previous question posted asked about private mileage allowance but the mileage details from the question had been removed. Psychic abilities not one of my attributes :).

Thanks (1)
Replying to gainsborough:
paddle steamer
By DJKL
27th Jun 2020 13:15

Could be a bit like doing skeleton crosswords for accountants(where the grid is not complete and one has to assemble it with the clues given) , you are only supplied with part of the question and the solution and the accountant then has to try to work out the missing information.

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Replying to DJKL:
Scooby
By gainsborough
27th Jun 2020 13:20

Turn it into a gameshow and that'll be my Saturday nights sorted!

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Replying to Matrix:
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By SXGuy
28th Jun 2020 10:09

Taxable income is 87500. You don't pay tax on the first 12500.

Maybe its worded in a way only accountants would understand. But most of us do understand when something is referred to as taxable income it's after untaxed income.

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Replying to SXGuy:
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By Matrix
28th Jun 2020 10:23

No, Gainsborough has made it clear that the question was copied incorrectly and started with £100k.

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Replying to gainsborough:
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By lukayl
27th Jun 2020 14:04

Hi, as I think from the question the PA is irrelevant here, so I just deducted it from the employment income to give the taxable income directly.

As for the second question, I still don't get it.

I self-study, so really can't seek help from tutor but online.

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Replying to lukayl:
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By Matrix
27th Jun 2020 15:45

That was not made clear in your post.

If a higher rate taxpayer pays £60 into a pension scheme then the pension provider reclaims 20% (£20), so the basic rate income tax. To obtain higher rate tax relief, the taxpayer includes the gross dividend on their tax return to obtain relief for the remaining 20% (£20). In practice the basic rate band is extended by the gross amount to achieve this relief.

The way I check when I complete tax returns is to take the net amount and gross it up so £60/o.6 = £100.

I would check your study notes since it will all be explained in there.

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Replying to Matrix:
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By lukayl
27th Jun 2020 16:07

Matrix wrote:

That was not made clear in your post.

If a higher rate taxpayer pays £60 into a pension scheme then the pension provider reclaims 20% (£20), so the basic rate income tax. To obtain higher rate tax relief, the taxpayer includes the gross dividend on their tax return to obtain relief for the remaining 20% (£20). In practice the basic rate band is extended by the gross amount to achieve this relief.

The way I check when I complete tax returns is to take the net amount and gross it up so £60/o.6 = £100.

I would check your study notes since it will all be explained in there.


Apart from directly giving the taxable income figure istead of the gross income figure, the question is exactly what provided in the revision kit. Anyway, I digress.

Return my question:
The study notes/textbook really doesn't make much of it.
All I know from them is that for personal pension contribution, only pays the net amount of the contribution, and HMRC grossed up with the 20%. And for higher rate/additional rate taxpayers, their bands are extended to the amount of gross personal pension contribution to attract tax relief. But I couldn't relate this with what you are saying.
For example, you are saying "if a higher rate taxpayer pays £60 into a pension scheme then the pension provider reclaims 20% (£20), so the basic rate income tax." For this, I assume you meant the higher rate taxpayer paying £60 is a net amount? But if so, £60*20%=£12, why it is £20? Besides shouldn't the grossing up formula to be: £60*20/80=£15?
Similarly, "To obtain higher rate tax relief, the taxpayer includes the gross dividend on their tax return to obtain relief for the remaining 20% (£20)", I assume you meant higher rate taxpayer attracts 20% tax relief? But same as above, why *20% = £20?
Finally, I can't get your grossing up formula £60*60/100=£100 either.

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Replying to lukayl:
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By Matrix
27th Jun 2020 16:09

£100 is the income before tax. So, yes, £60 is the net amount.

£60/0.6 = £60 x 100/60 = £100

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Replying to Matrix:
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By lukayl
27th Jun 2020 16:21

Matrix wrote:

£100 is the income before tax. So, yes, £60 is the net amount.

£60/0.6 = £60 x 100/60 = £100


But how is it benefit in this way? Like in the answer it says for each £100 saved will effectively only cost £60, so I only pay £60 in the pension contribution, how can I save £100 in return?
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Replying to lukayl:
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By lukayl
27th Jun 2020 16:43

lukayl wrote:

Matrix wrote:

£100 is the income before tax. So, yes, £60 is the net amount.

£60/0.6 = £60 x 100/60 = £100

But how is it benefit in this way? Like in the answer it says for each £100 saved will effectively only cost £60, so I only pay £60 in the pension contribution, how can I save £100 in return?


Nevermind, I tried my luck on YouTube to see if there is some video tutorial explanation out there, and I was directed to this link below:
https://www.which.co.uk/money/pensions-and-retirement/personal-pensions/...
I think I get the hang of it now.
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Replying to lukayl:
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By Matrix
28th Jun 2020 08:38

OK great. Would you like to thank everyone who helped you? If not then it may affect any help you get in the future.

Thanks (3)
Replying to lukayl:
Maddy Christopher
By Maddy Christopher
29th Jun 2020 11:35

lukayl,

Given the time and effort users have put into assisting you with your question, your response appears dismissive and impolite.

I would advise a more gratuitous reply to those offering you help in future.

Thanks (4)
Replying to Maddy Christopher:
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By Cheshire
29th Jun 2020 11:40

Can I suggest a private message as well, Maddy, if you havent done it already, otherwise it is highly likely the OP will not see this (most only come back on when they think there is an answer pending, unlike many of the regulars who review most posts as a matter of course.)

Thanks (1)
Replying to Cheshire:
Maddy Christopher
By Maddy Christopher
29th Jun 2020 11:47

Already done Cheshire,

I contacted lukayl earlier, but I decided to add a comment here as it's useful for other users like lukayl to see the response as well.

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Replying to Maddy Christopher:
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By Paul Crowley
29th Jun 2020 11:57

Much appreciated. Respnders do look to help, but really need the full question otherwise things just get more confused

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Replying to Maddy Christopher:
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By Cheshire
29th Jun 2020 11:57

Fab. Thank you.

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Replying to Maddy Christopher:
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By Matrix
29th Jun 2020 12:33

Thanks Maddy, this is the last time I reply to students.

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Replying to Matrix:
Maddy Christopher
By Maddy Christopher
29th Jun 2020 12:57

Not all of them I hope, Matrix. I'm sure many, like me, remember having impeccable manners as a student.

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Replying to lukayl:
By Paul D Utherone
29th Jun 2020 14:41

lukayl wrote:

lukayl wrote:

Matrix wrote:

£100 is the income before tax. So, yes, £60 is the net amount.

£60/0.6 = £60 x 100/60 = £100

But how is it benefit in this way? Like in the answer it says for each £100 saved will effectively only cost £60, so I only pay £60 in the pension contribution, how can I save £100 in return?

Nevermind, I tried my luck on YouTube to see if there is some video tutorial explanation out there, and I was directed to this link below:
https://www.which.co.uk/money/pensions-and-retirement/personal-pensions/...
I think I get the hang of it now.

1) You pay the pension company £80
2) The pension company claims £20 for the BR from HMRC , so your pension pot is better off by £100
3) If you're BR taxpayer that's it. You paid £80 and your pension pot goes up by £100
4) If you're HR taxpayer then:
a) you pay £80,
b)your pension pot increases by £100,
c)you claim HR relief on £100 through your tax return reducing your tax liability by £20 [£100 x (40-20)%]
d)the net cost to you is £60 [£80 paid to pension co less £20 HR tax reduction] but your pension pot has gone up by £100

Thanks (1)
Replying to Paul D Utherone:
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By lukayl
30th Jun 2020 10:01

Paul D Utherone wrote:

lukayl wrote:

lukayl wrote:

Matrix wrote:

£100 is the income before tax. So, yes, £60 is the net amount.

£60/0.6 = £60 x 100/60 = £100

But how is it benefit in this way? Like in the answer it says for each £100 saved will effectively only cost £60, so I only pay £60 in the pension contribution, how can I save £100 in return?

Nevermind, I tried my luck on YouTube to see if there is some video tutorial explanation out there, and I was directed to this link below:
https://www.which.co.uk/money/pensions-and-retirement/personal-pensions/...
I think I get the hang of it now.

1) You pay the pension company £80
2) The pension company claims £20 for the BR from HMRC , so your pension pot is better off by £100
3) If you're BR taxpayer that's it. You paid £80 and your pension pot goes up by £100
4) If you're HR taxpayer then:
a) you pay £80,
b)your pension pot increases by £100,
c)you claim HR relief on £100 through your tax return reducing your tax liability by £20 [£100 x (40-20)%]
d)the net cost to you is £60 [£80 paid to pension co less £20 HR tax reduction] but your pension pot has gone up by £100


Thank you.
Thanks (0)