Some general advice on income tax and private pension contributions

[egdeif]

Hi

I was wondering if anyone could give me a steer on something, as I cant quite get my head around it.

I am employed full time, and I pay higher rate tax at 40%

I had the opportunity to take on some work outside of that employment, let's call it a sideline consultancy. I decided I needed to register for self assessment so I could declare this additional activity.

The money I earned from this sideline, I was wondering, if I place all of into my private pension would I in effect cancel out my tax liability for this additional earning?
When I put money into my pension, I immediately get basic rate tax relief. That's nice, but what I cant get my head around is that HMRC are giving me additional money but I havent paid any tax to deserve it back? let's say I've earned £5000 and I put the whole lot into my pension, and I get an instant 20% on top of that so £6000. Are HMRC going to ask me for that £1000? if they did, I'd then have to find this money elsewhere to pay that back, from money I've already paid tax on.

The same query arises in my mind for claiming the additional higher rate relief. If I go ahead and claim that, is it somehow credited to my pension account? do HMRC tell me I dont owe them more tax. I'm confused - HMRC giving me some more money, but I havent yet paid any tax on that. My thinking keeps coming back the fact that HMRC have given me something, but I havent paid tax on it and am I going to end up owing something.

To restate my objective here, I had the impression that if I put my additional income in my pension, I would not owe any tax on it at the end of the financial year and I get to keep everything I earned. OK I wont have access to it to spend as it'd be locked in my pension.

If any helpful person could give me a bit of clarity on this I'd really appreciate it.

Thanks

[billypiper]

So

say you earn £5000

You commit £5.000 to the pension fund to your pot

So you only pay £4000 as the taxman has paid the insurance company £1,000.

When you complete your tax return you will declare £5000 and the tax on that is £2000

That £2,000 tax bill is reduced by the pension contribution to £1,000.

So £1,000 by source £1,000 by reduction so you have received full relief on the contribution.

The adjustment for the pension contribution on the return is complicated. Just submit you return early and HMRC will do it for you.

[egdeif]

thanks very much for your reply. So I think I can take it to mean that I'll owe no payments to hmrc on it after claiming the full tax relief at 40%?

[billypiper]

yes

[D&C]

I disagree.

In the scenario given you will owe HMRC £1,000 (Self Assessment bill)

You will have a pension fund of £5,000 having only given the pension company £4,000 but in this situation you are always going to have at least £1,000 tax to pay on the self employed profit of £5,000.

[egdeif]

Hi

I think this got mixed up a bit as billypiper mentioned 4000.

I earnt 5000, and I put the whole lot into my pension. There's nothing left to be taxed.

My confusion is that HMRC are then going to give me tax relief on that amount, at 40% that's £2000.

So do I now owe HMRC 2000? wouldnt it be easier if the pension lot just did not apply any relief, and then HMRC tell me I owe them nothing? that way I have earned relief, i havent given them anything and they've effectively cancelled out what I owe them in tax.

[billypiper]

If you paid £ 5000 to the insurance company they would have claimed £1250 so a gross premium of £6250

Only contributions from Ltd companies can be paid gross

Is your employment pensionable ie do you contribute the maximum to that? prob not then you can use that to justify the contribution of £6250

[robbob]

Seems a bit of a confusing thread here.

I would expect it to work as follows - if you earn 5k (taxable at higher rate) and you add 5k grossed up into your pension (relief on which is eligible at 40%)

You earn 5k have 40% tax deducted so have £3,000 cash in your pocket.
To add 5k (grossed up) into pension if contribution is from you is 80% of 5k = £4,000 - hmrc add 25% of the 4k directly into your pension - 20% of grossed up sum.
In summary you need to find £1k extra cash to add into your pension that comes form "other savings"

However at end of tax year (tax return submision) or via a coding adjustment you get tax refund of 20% based on grossed up pension contribution - £5k * 20% = £1k - so you basiclaly get the 1k back you had to pre fund and the end result is that 100% of 5k earned is in your pension - simples. In summary 20% relief given at source by hmrc adding to pension pot and other 20% refunded when its provded you are higher rate taxpayer. Note you can get an in year tax code adjustment done to give you relief during the year - this can be risky though if its not 100% certain you will be higher rate taxpayer.

Probably best done via salary sacrafice via employment or matched by employer if that is an option as that may save on NI.

[egdeif]

Hi, many thanks for taking the time.

I think I've got this all wrong. I was thinking I could take my 5k and just pay it straight into my pension to avoid any taxation on it. But it seems I must first earn it, then declare it, then pay tax on it then put it in the pension and get the tax paid back via relief, albeit all locked up in my pension (which is OK). So it makes sense now, I pay the tax at basic and higher rate, then via the pension I get 40% back that way and therefore has the effect of cancelling out the tax.

Salary sacrifice is great and already do that via my usual employment. This is sideline so I'm being paid directly by customer and not as an employee of their business.

It's a bit confusing tbh, I mean, I have 5000, I pay tax on that so that's 2000 gone, that leaves me with 3000. I then have to find some other money from some where else, i.e. that 2000 to make it up to 5000 again temporarily, I then get my tax relief back via the pension account but its locked away, meanwhile I've put 2000 away of my own funds... but I think this is where you explain with the tax code system in that I'll get that refunded probably over the course of a year though I'd prefer them to just pay me back in one go

[D&C]

You are getting confused with your figures.

If you make a £5k profit and you pay that £5k into a personal pension or SIPP it would be a "relief at source" contribution. The pension company would add 25% giving you a gross contribution of £6,250.

You then declare the £5k profit on your Self Assessment return and are charged £2k in income tax as a relief at source pension contribution does not reduce your taxable income.

But you do declare the £6,250 gross pension contribution on your Self Assesment return and this will increase the amount of basic rate tax you can pay by £6,250. In turn reducing the amount of higher rate tax payable. If you have paid sufficient higher rate tax this can mean the pension contribution is saving you £1,250 in income tax.

A simpler way of looking at it might be yes you will owe £2k tax on the profit but you will have a pension fund of £6,250 which only really cost you £3,750 (the £5,000 you actually handed over to the pension company less the £1,250 personal tax saving).

All of the above us assuming you are paying sufficient higher rate tax to be liable at higher rates on the profits and will receive higher rate tax relief on all of the pension contribution.

For you own sanity you might want to avoid a claim through your tax code, just include the details on your Self Assessment return.