Personal Contributions and Tax Relief
For Use By Financial Advisors Only
This note is for general guidance only and is based on our understanding of the current position relating to contributions. Specific advice should be sought in respect of any individual wishing to make pension contributions.
Personal Contributions and Tax Relief Background
When an individual pays a contribution to a pension scheme, they will normally be entitled to tax relief on the payments that they make. This means that the contribution will usually benefit from an associated payment being made by HM Revenue & Customs (HMRC) into the pension fund of the individual – either directly in the form of a physical payment of money, or indirectly in that the payment is made before the deduction of income tax. There are, however, a number of conditions that need to be met before an individual can obtain tax relief.
Personal Pension Contributions and Tax Relief Summary
- Contributions are paid by individuals net of basic rate tax. This means that an individual pays 80% of the total amount they wish to put into the pension. The balance is reclaimed from HMRC.
- For an individual to be able to obtain tax relief they need to be an active member of a registered pension scheme, and a relevant UK individual in the tax year in which the contribution is paid.
- There are two principal methods of obtaining tax relief: net pay arrangement, and relief at source. The former is a method where an employer deducts the amount from salary prior to taxation. Relief at source involves the payment of the net amount followed by a reclaim from HMRC.
- Personal Pension Schemes, including SIPPs, cannot operate the net pay arrangement. This means that when individuals redirect contributions to SIPPs from employer schemes, they must ensure that any member contribution is arranged on a relief at source basis.
- Higher rate taxpayers need to claim additional tax relief between their basic and marginal rate using self assessment.
Relevant UK Individual
Broadly, a relevant UK individual must have relevant UK earnings chargeable to income tax for that tax year; be resident in the UK at some time in that tax year; were resident in the UK at some time during the five tax years immediately before the tax year in question; and were resident in the UK when they joined the Scheme. Relevant UK earnings is in essence employment income (salary, wages, bonus, overtime etc), and income derived from the carrying on of a trade, profession or vocation.
Level of Pension Contributions & Tax Relief
The maximum amount of contributions on which an individual can reclaim tax relief in any tax year is the greater of the ‘basic amount’ (currently £3,600 gross) and the amount of the individual’s relevant UK earnings that are chargeable to income tax for the tax year.
The individual is also subject to the Annual Allowance for the tax year in question, although Carry Forward can be used to allocate contributions to three previous tax years, provided the individual is not subject to the Money Purchase Annual Allowance (which restricts contributions to £10,000 per annum gross, and prevents use of Carry Forward), or tapering (which gradually reduces an individual’s Annual Allowance if they have income, including pension contributions, in excess of £150,000).
Methods of Tax Relief
Relief at Source: This allows an individual to make a pension contribution by deducting an amount equal to basic rate income tax from the total amount. The Scheme Administrator then makes a claim from HMRC for the sum deducted.
Net Pay: This operates where an employer deducts the relievable pension contribution from taxable income before accounting for PAYE. The individual therefore gets tax relief at their marginal rate of income tax.
Relief on making a claim: This operates where an individual makes a contribution to a pension scheme and claims tax relief from HMRC, usually via their tax return. This is usually the option used where relief at source or net pay methods are not available.
Types of Scheme & Tax Relief
Personal Pension Schemes (including SIPPs) cannot operate the Net Pay arrangement. An individual who redirects pension payments to a SIPP from a previous scheme must be careful about ensuring they do not continue to use a net pay arrangement that existed previously.
Occupational Schemes (including SSASs) cannot operate the Relief at Source method without
applying to HMRC for permission to do so. In addition, a Scheme cannot operate both types of
relief, so once registered a SSAS would only operate on a Relief at Source basis.