Make sure you get the correct tax relief for pension payments.
Pension contributions can be a complicated area but thankfully for self employed people with personal pensions it should be fairly straightforward. However, many clients do not understand exactly how the tax relief works and so may give their accountants incorrect pension information for the tax return – or miss them out altogether.
There are also complicated rules governing the amounts that can be paid into a pension scheme annually which may – if exceeded – create additional tax liabilities.
So here is a quick recap to help.
Basic rate taxpayer
When a contribution is paid the pension scheme reclaims income tax at the basic rate on behalf of the taxpayer and adds it to their pension pot. Therefore all of the relief is claimed and for a basic rate taxpayer the actual tax return entries will not affect the tax liability. Note that if the taxpayer’s rate of Income Tax in Scotland is 19% the pension provider will claim tax relief at a rate of 20%. The difference does not need to be repaid.
The pension contributions need to be disclosed on the tax return even when the relief has been claimed at source by the scheme. In addition the amounts contributed must be put down gross, ie not the actual amount paid but grossed up for the tax relief claimed at source. Make sure that your client has given you the correct figures and whether they are gross or net.
Example
Emma paid £700 into her pension scheme.
She puts £875 in box 1 (£700 divided by 80 and multiplied by 100), which is her net payment plus the tax relief of £175 (£875 at 20%).
The reason for the ‘gross’ entry is explained below.
Higher rate taxpayer
Where the person is a higher rate taxpayer or additional rate taxpayer, additional tax relief may be claimed. This is claimed through an extension in the basic rate band and higher rate band. Both bands are extended by the gross amount of thecontribution. Hence it is important for the client not to get confused between net and gross payments as this may directly affect the tax liability.
Example (courtesy of Tolleys) ― illustrating higher rate tax relief given by extending the basic rate band
Mr Hubert is self-employed and lives in Birmingham. He pays £600 net per month into his pension scheme. He has taxable trading profits of £70,000 and receives bank interest of £7,500 each year.
Mr Hubert
Income tax calculation
Year ended 5 April 2019
| Total income | Non-savings income | Savings income | |
| £ | £ | £ | |
| Trading income | 70,000 | 70,000 | |
| Savings income | 7,500 | ______ | 7,500 |
| Total income | 77,500 | 70,000 | 7,500 |
| Less: personal allowance | (11,850) | (11,850) | ______ |
| Taxable net income | 65,650 | 58,150 | 7,500 |
| Tax thereon: | £ | ||
| Non-savings | £43,500 (W1) (N1) | @ 20% | 8,700 |
| £14,650 (N1) | @ 40% | 5,850 | |
| Savings | £500 (N2) | @ 0% | Nil |
| £7,000 (N2) | @ 40% | 2,800 | |
| Tax due | 17,350 |
Workings
(W1) Extending the basic rate band and savings basic rate band:
| £ | |
| Basic rate band / savings basic rate band | 34,500 |
| Plus: gross pension contribution | |
| 9,000 | |
| Extended basic rate band | 43,500 |
Notes
- 1) Non-savings income is first taxed at the basic rate of 20% using the extended basic rate band. The non-savings income is more than the extended basic rate band and therefore £14,650 (£58,150 – £43,500) of non-savings income falls within the higher rate band.
- 2) The amount of the savings nil rate band depends on the taxpayer’s marginal rate. Higher rate taxpayers, such as Mr Hubert, have a savings nil rate band of £500. The balance of the savings income, which amounts to £7,000 (£7,500 – £500), is taxable at the savings higher rate of 40%. See the Taxation of savings income guidance note.
- 3) As Mr Hubert is self-employed, it is likely that he would have already paid some of his tax liability under the payment on account regime.
Special pension contributions
There are some specific contributions that need to be treated differently so again the devil is in the detail:
- payments to a retirement annuity contract. These are becoming less common now. There is a specific box on the tax return for this as the (RAC) provider doesn’t use the ‘relief at source’ scheme and so they don’t claim the basic rate (20%) tax relief on behalf of the taxpayer. The total personal contributions to the RAC in the 2017 to 2018 tax year should be included in box 2
- payments to your employer’s scheme which were not deducted from your pay before tax. There are various reasons why this might happen but again it may mean that basic rate tax relief has not been given and so needs claiming. The total unrelieved amount paid in the 2017 to 2018 tax year should be included in box 3
- payments to an overseas pensions scheme – these may attract tax relief if they are eligible and were not deducted from pay before tax. The amount that directly qualifies should be included in box 4.
Company pension schemes
Remember that normally the relevant entries on the tax return relate to personal pension contributions. So if a tax payer is part of a company pension scheme these contributions should not be confused with personal ones.
Maximum contributions
The maximum contribution to a pension fund that a taxpayer can obtain tax relief for in any one tax year is the higher of 100% of his ‘relevant earnings’ for that year and the basic amount (£3,600). In effect anybody can pay up to £2,880 per year into a pension scheme regardless of the level of his or her earnings. Up to this limit, the pension scheme will claim basic rate tax relief. Grossing up for 20% basic rate tax makes the gross contribution £3,600.
Annual allowance
There is an annual allowance and if pension contributions go above this, tax may be payable. ‘Pension input’ broadly means employee’s plus employer’s pension contributions in the tax year. The allowance for 2017/18 is £40,000.
If the annual allowance for the current tax year (6 April to 5 April) is fully used, the taxpayer can carry over any unused allowance from the previous three tax years. Carry over unused allowance from the earliest tax year first.
Complications:
- if the taxpayer is already accessing the pension, the annual allowance may be reduced and tax payable when exceeded
- higher paid taxpayers have a reduced annual allowance. Look at adjusted incomes over £150,000. Follow this link for HMRC’s reduced allowance calculator
- the annual allowance includes all pension schemes. This is an important planning/timing issue as the client needs to get all of the necessary information from each scheme they contribute to.
And finally don’t forget the lifetime cap. It was reduced significantly over a number of years, reaching £1,000,000 for 5 April 2016. Increases in line with inflation apply and from 6 April 2018 the cap increased to £1,030,000 and will increase to £1,055,000 from April 2019.
Article from ACCA In Practice