Many higher rate tax payers don’t know they can claim on their pension contributions

Firstly, lets define what a higher rate taxpayer is. At the time of writing, a higher rate taxpayer is anyone with income over £50,271 in the tax year 2021/22, and they will pay 40% tax on income above this, rising to 45% above £150,000, called an additional rate taxpayer. If you are a higher or additional rate payer, you could be able to claim the additional 20-25% from your pension contributions to ensure you get full relief for everything you pay in. This won’t happen automatically though, and HMRC don’t exactly advertise the fact, so you need to claim it yourself through a self-assessment tax return,

The idea behind tax relief on your pension contributions is that all income paid into your scheme should be exempt from income tax, however as people are taxed differently depending on whether they are employees (taxed at source through the PAYE scheme), or self-employed through a self-assessment, tax relief on pension contributions should be repaid to you on every penny you contribute (as long as you are within the annual allowances, currently £40,000 p.a. if under the tapered high income threshold).

What scheme am I on?

In practice, only employees who have their pension contributions deducted from their salary before tax receive full tax relief at source, this is called a net pay arrangement. So, if you were to earn £3,000 a month and contribute 5% (£150) of this into your pension, you would only pay tax on £2,850 of your salary. Your employer will be able to tell you if you are on a net pay arrangement.

However, relief at source arrangements work differently, where your contributions come from your income after tax has been deducted already. With this setup you pay 80% of your salary/wage, and the government top up the extra 20% to your pension fund. Taking the above example, you would pay £120 to the pension fund and the government would top this up with the additional £30 (20%). Some employed people, the self-employed and those who contribute to a personal pension would fall into this category.

Why would I contribute more to my pension, it reduces the cash I have to spend?

Some people are concerned about contributing more into their pension mainly because it means they will have less in their bank to enjoy now, and whilst there is some basis to that argument the numbers stack up to suggest that if you have additional income (especially higher and additional rate taxpayers), at least some of it is best invested into a pension. Take a simple £100 example, if you pay 40% tax on £100 it is reduced to £60, that is it, the £40 has gone to the tax man. However, if you then pay that £60 into a pension, the income tax is repaid – making it up to £100 again. That £60 turned into £100 is an increase of around 66%, and you will struggle to find to find that immediate growth elsewhere, so higher-rate pension contributions really are worth considering.

Claiming higher rate tax relief

Unless you are on the net pay arrangement, you will actively have to claim your higher/additional rate tax. The simplest way to do this (unless it’s a one off) is to file a self-assessment each year. Here you can add in your contributions made in the year and you will get an extra 20% tax relief depending on your salary and contributions in the year. This can be paid directly to you in the form of a refund of tax or added to your tax code (if you submit your self-assessment early enough) so that you pay less tax on your salary throughout the year.

You can backdate claims

If you were a higher/additional rate taxpayer in the past four years you are able to backdate your claims for this period. Welcome new if you have just realised you should have been claiming!

Other key points

• There is an annual allowance of £40,000 per year you can contribute to your pension (this is lowered if you breach high income thresholds).
• If you haven’t used up the £40,000 allowance in the previous 3 years, you can carry forwards any unused allowance to the current year (once you have used the current year £40k)
• A lifetime maximum allowance of £1,073,100, if you go above this you will incur tax charges.
• Other people can contribute to your pension and you will still receive tax relief. The person contributing won’t get any relief, but if somebody was looking to give you some funds, this would be a tax efficient way of doing so!

If you would like to know more about the reliefs and claiming them, please get in contact and we can look at your specific circumstances.