Tax relief on pension contributions

Recently many workplace pensions have been set up under the Auto Enrolment (AE) pension scheme.
 
It is important that you and your employees understand the tax relief associated with pension payments and whether they qualify for further tax relief.
 
There are two main tax relief arrangements that apply to employee pension contributions – ‘net pay arrangement’ and ‘relief at source.’
 
1. A net pay arrangement is where the employer takes the employee’s pension contributions from their pay before it’s taxed. The employee therefore only pays tax on the amount left after the pension contribution has been deducted and therefore they have already received maximum tax relief.
 
2. A relief at source scheme involves the employer deducting the employee’s contributions after taking tax from the pay. The pension provider then receives the associated tax relief from HMRC, which is paid directly into the pension fund. This is how an AE pension scheme operates.
Anyone with a relief at source scheme that pays higher rate tax (40% on income exceeding £45,000 for 2017/18 for English and Welsh taxpayers) may be entitled to further tax relief. They will be normally be required to complete a Self-Assessment Tax Return to claim this additional tax relief.
 
Example
 
Sandra earns £55,000 from her role as bank manager with a large international bank.
 
She has a relief at source pension plan and pays £400 a month into the pension scheme. £100 a month is added to the pension by HMRC in respect of the 20% tax relief, making a gross contribution of £500 a month to the pension or £6,000 per annum.
 
As Sandra earns more than £45,000, she is a 40% taxpayer. Sandra is therefore entitled to an additional 20% tax relief on the full £6,000 pension contribution. Sandra completes a Tax Return to claim this amount and receives a tax refund of £1,200 from HMRC. 
 
Relief for earlier tax years can also be claimed if the claim is submitted to HMRC within four years of the end of the tax year that the claim relates to.
 
Further rules
 
There are further rules, not covered by this article, which dictate the amount of contribution that can be made to a pension to achieve tax relief. Anyone with income over £110,000 should have their circumstances reviewed.
 
Please note that if you contribute to a pension plan set up prior to July 1988, then the tax relief will be calculated differently to the above.
 
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