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Contributions and Tax Relief

JonnyT
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Contributions and Tax Relief

#332212

Postby JonnyT » August 10th, 2020, 5:55 pm

I've come into an inheritance and and weighing up options re tax.

Currently I'm comfortably a higher rate tax payer and pay into a workplace pension using salary sacrifice. Total monthly contributions are circa £510.

I understand I can put £40k per year into pension and backdate for three years?

My questions are thus:
To contribute the £40K max I believe that I actually pay £32K and the Government tops this up to £40k. Is this correct?
As a higher rate tax payer I then get £13K tax relief, effectively worth £5k? How does this work? Do I claim it on my tax return? Do they pay this back immediately or do they reduce my tax over the next 12 months?
Given my salary sacrifice as above how does this reduce what I can put into the pension?
What if I claimed the whole three years in one go?

Urbandreamer
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Re: Contributions and Tax Relief

#332226

Postby Urbandreamer » August 10th, 2020, 6:48 pm

JonnyT wrote:I've come into an inheritance and and weighing up options re tax.

Currently I'm comfortably a higher rate tax payer and pay into a workplace pension using salary sacrifice. Total monthly contributions are circa £510.

I understand I can put £40k per year into pension and backdate for three years?

My questions are thus:
To contribute the £40K max I believe that I actually pay £32K and the Government tops this up to £40k. Is this correct?
As a higher rate tax payer I then get £13K tax relief, effectively worth £5k? How does this work? Do I claim it on my tax return? Do they pay this back immediately or do they reduce my tax over the next 12 months?
Given my salary sacrifice as above how does this reduce what I can put into the pension?
What if I claimed the whole three years in one go?


I think that you are confusing a number of different ways pensions are dealt with.

Consider this.
Your employer puts £1k into a pension for you. Nothing to do with salary, they just do it.
As it's not salary they don't pay tax on that £1k and the government doesn't "top it" up by anything as the top up is a return of income tax.
The company may decide to reduce your salary. Most would reduce it by less than £1k.

Now consider that the employer doesn't pay anything into your pension (Ok ignore current regs).
Instead they pay you an extra £1k, which costs them about £1120. Ie the £1k they nominally pay you and the employers NI.
You don't however receive £1k, employee's NI is first removed and then you pay 40% of the £1k.
You then take that money and pay it into a pension scheme.
The government "tops it up" by 20%, the standard rate of tax.
However since you paid more than 20% income tax, you write to HMRC or fill in a form and they return the 20% that didn't automatically top up your pension.

In practice most people have both employee and employer contributions.
I know how much my employer contributes via salary sacrifice.
I also contribute to a SIPP out of taxed income, which is not the most tax efficient way for me to build a pension, but it's what I want to do.

Were I in your situation I could work out how much of the £160k won't have been paid in the three previous years from the end of this tax year. I could them do the tax sums to calculate what I need to contribute to a pension as employee contributions. But as a standard rate tax payer my tax is simple. It isn't for higher rate tax payers.

If you expect to continue working for your current employer for some time then you could greatly increase your level of salary sacrifice for a few years and pay yourself that amount from the inheritance until it's used up. Then restore your salary sacrifice to previous levels. That might be financially your best option.

It is probably worth paying a IFA for advice. I have made a number of assumptions about your tax situation and have no qualifications in the area.

ursaminortaur
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Re: Contributions and Tax Relief

#332254

Postby ursaminortaur » August 10th, 2020, 8:23 pm

JonnyT wrote:I've come into an inheritance and and weighing up options re tax.

Currently I'm comfortably a higher rate tax payer and pay into a workplace pension using salary sacrifice. Total monthly contributions are circa £510.

I understand I can put £40k per year into pension and backdate for three years?


Not quite. Assuming you have a salary, after salary sacrifice, bigger than £40,000 but not large enough to take you into taper territority then your annual allowance will be £40,000. If you have been in a pension scheme for the past 3 years and have unused allowance in those three years then that can be carried forward starting with the earliest of those three years in effect increasing this year's allowance. However the maximum that you can put in even with this increased allowance is your relevant earnings this year. This might well mean that you could only use up the first (or possibly first and second) of those three previous years unused allowances and would have to wait until you could use the same procedure next year to use up the rest.

https://www.pensionsadvisoryservice.org.uk/about-pensions/saving-into-a-pension/pensions-and-tax/carry-forward

To use carry forward, you must make the maximum allowable contribution in the current tax year (£40,000 in 2020/21) and can then use unused annual allowances from the three previous tax years, starting with the tax year three years ago.

You can’t receive tax relief on contributions in excess of your earnings in a tax year and you only receive higher rate tax relief to the extent that you have paid it.

If a particular tax year’s unused annual allowance is not fully used, it can only be carried forward for up to three years, after which it is lost.



JonnyT wrote:My questions are thus:
To contribute the £40K max I believe that I actually pay £32K and the Government tops this up to £40k. Is this correct?
As a higher rate tax payer I then get £13K tax relief, effectively worth £5k? How does this work? Do I claim it on my tax return? Do they pay this back immediately or do they reduce my tax over the next 12 months?
Given my salary sacrifice as above how does this reduce what I can put into the pension?
What if I claimed the whole three years in one go?


Your relevant earnings for the year will be reduced by the salary sacrifice to your post salary sacrifice salary thus reducing the additional amount that you could pay into a pension this year by using carry-forward.

https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/interaction-of-tax-relief-and-annual-allowance/

Where salary sacrifice takes place, it is only the taxable amount of salary the member actually receives which is relevant earnings if they are looking to make additional personal contributions.

JonnyT
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Re: Contributions and Tax Relief

#332462

Postby JonnyT » August 11th, 2020, 5:22 pm

Thanks for the replies guys, much clearer now :)


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