Tax relief on member contributions

Author Image The Technical Team
19 minutes read
Last updated on 6th Apr 2019

Overview

Learn how tax relief for a member operates including eligibility, methods of claiming tax relief and case studies.

Key points

  • Tax relief for a member is only available if the member is a relevant UK individual.
  • There are three ways in which tax relief can be received - net pay method, relief at source and claiming from HMRC.
  • The overall tax relief will be the same using net pay and relief at source but the calculation works differently. (NB there is no tax relief for a contribution from earnings up to the personal allowance using the Net Pay method - more later)

Who may contribute?

Pension contributions can be paid by:

  • an individual who is a member of a pension scheme
  • that individual's employer
  • a third party on behalf of that individual.

This article relates to how tax relief operates on pension contributions made by individuals or on their behalf by a third party. The tax treatment of employer contributions is covered in our Tax relief on employer contributions

Tax relief is given on contributions 'paid' during a tax year. They must be a monetary amount and paid for example, by cash, cheque, direct debit etc.

There’s 'no limit' to the amount of contributions that can be paid. There are, however, limits to the amount of tax relief that can be obtained on those contributions.

This article deals with UK tax relief.

Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. NSND income includes employment income, profits from self-employment (including sole trades and partnerships), rental profits, and pension income (including the state pension). Similarly, from 6 April 2019 Welsh Taxpayers will pay the Welsh Rate of Income Tax (CRIT (C for Cymru)) on NSND income.  

Other tax and deductions such as Corporation Tax, dividends, savings income and National Insurance Contributions etc. will remain based on UK rules. This could mean the amount of income tax relief which can be claimed on pension contributions by Scottish and UK tax payers may not be the same. For more info on SRIT and how this works in practice, please visit our facts page. For more info on CRIT and how this works in practice, please visit our facts page.

Eligibility and contributions

Relevant UK individuals

Tax relief is available on pension contributions paid by or on behalf of an individual, who is under age 75, if he or she is a 'relevant UK individual'. This means they:

  • have relevant UK earnings chargeable to income tax for that tax year,
  • are resident in the United Kingdom at some time during that tax year,
  • were resident in the UK at some time during the five tax years immediately before the tax year in question and they were also resident in the UK when they joined the pension scheme, or
  • have for that tax year general earnings from overseas Crown employment subject to UK tax (as defined by section 28 of the Income Tax (Earnings and Pensions) Act 2003), or
  • are the spouse or civil partner of an individual who has for the tax year general earnings from overseas Crown employment subject to UK tax (as defined by section 28 of the Income Tax (Earnings and Pensions) Act 2003).

No tax relief is available on contributions paid by or on behalf of individuals who are not 'relevant UK individuals'.

Personal contributions

For tax relief purposes personal contributions include both those paid by the individual member and those paid by a third party for that individual member.

If a self-employed individual makes a pension contribution for themselves, this is treated for tax purposes in the same way as any other personal contribution.

Tax relief is given to the individual – not the third party – and is calculated based on the individual's circumstances. For example, if a parent or guardian pays a contribution for their adult child, the amount payable and tax relief will be calculated based on the adult child's income/earnings.

For clarity, salary sacrifice - a formal contract where the employee swaps some salary for an employer pension contribution instead – will lead to a reduction in the personal tax bill.  This is because the employee doesn’t receive the amount of salary given up and, therefore, won’t pay tax or National Insurance contributions on that amount.

Relevant UK earnings

The levels of tax relief available depend on the member's relevant UK earnings in the current tax year.

These are the earnings available to base a pension contribution on. Generally, all earned income is relevant earnings.

It’s sometimes easier to think about what are not relevant earnings and this includes pension income, dividends and most rental income.

HMRC define relevant earnings as:

  • employment income such as pay, wages, bonus, overtime, commission (providing it is chargeable to tax under Section 7(2) ITEPA 2003)
  • income chargeable under Part 2 ITTOIA 2005, that is income derived from the carrying on or exercise of a trade, profession or vocation (whether individually or as a partner acting personally in a partnership)
  • patent income, where the individual alone or jointly devised the invention for which the patent in question is granted, in certain specific categories
  • general earnings from an overseas Crown employment which are subject to tax in accordance with section 28 of ITEPA 2003
  • rental income is generally not relevant earnings but some rental income may be included if it is in respect of UK or EEA furnished holiday lettings business

For full information see PTM044100

If the client receives a redundancy payment the first £30,000 is tax free and as such doesn’t qualify as relevant earnings. For example, if the client receives a redundancy payment of £120,000 the amount of relevant earnings is £90,000.

For self-employed individuals, their relevant earnings are profits calculated over their chosen period of account.  This does not need to align with the tax year ie 6th April to 5th April. We’ll cover this in detail later.

Where relevant UK earnings are not taxable in the UK due to double taxation agreements they are not relevant earnings.

Contributions that are not tax relievable

Not all pension contributions are relievable. The following do not qualify for tax relief for the member;

  • contributions paid after the member reaches age 75
  • new contributions that are life assurance premium contributions
  • employer contributions.

If a member has relevant UK earnings of less than basic amount of £3,600 but is making a contribution of more than the level of their earnings, relief at source (RAS) is the only method by which the member can get tax relief on the excess contribution (up to £3,600).

Let’s look at an example. Meg earns £2,500 pa. She pays £2,500 pa gross to a retirement annuity contract/ S226 plan which does not operate RAS. Only the £2,500 is paid in to her pension. There is no tax relief due.

However, Meg could instead pay £2,500 net to a personal pension plan which does operate RAS. This full contribution amount would be grossed up by basic rate tax relief, currently 20%, so £3,125 would be invested within the personal pension plan.

In fact, Meg could pay up to £2,880 net to a personal pension plan (grossed up to £3,600) even though she earns less than this amount.

Historical note: contracted out rebates (minimum contributions) did not qualify for tax relief though there is an element of relief included in the rebate amount.

Contribution status of other payments

Transfer values received and pension credit rights received from UK pensions schemes are not contributions.

Transfers of pension credit rights from non-recognised schemes and the transfer of certain shares from ‘save as you earn’ schemes can be treated as contributions and tax relief claimed.

In specie contributions

Contributions must be a monetary amount but it is sometimes possible for a monetary amount to be agreed between the member and the scheme and then the member makes good the 'debt' to the scheme by passing over an asset instead. This is known as an 'in specie contribution'

It is not possible to just contribute the asset at whatever its value may be.

There must be:

  • a specified monetary sum, that creates a debt recoverable by the scheme
  • a side agreement with the scheme to pay an asset in payment of the debt
  • the schemes agreement to accept the asset in lieu of the debt.

This is effectively the scheme acquiring an asset.

If the asset is valued at less than the monetary amount the balance must be paid in cash.

Tax relief works as normal based on the monetary amount.

In specie contributions have been a topic of discussion recently. Providers now have to separate cash and in specie contributions on relief at source claim forms. HMRC have challenged some of the RAS claims for in specie contributions. In Pensions Scheme Newsletter 86 in April 2017, HMRC stated that their position had not changed and remained as stated in PTM042100 which is described above. However, this has been subject to a recent court case and may be subject to change.

Methods of claiming tax relief

There are 3 ways to arrange for tax relief on members' contributions:

  • Net pay
  • Relief at source
  • Assessment – claim to HMRC.

Net pay

Used by occupational, employer-sponsored, pension schemes where member's contributions are paid over to the administrator by the sponsoring employer.

Under net pay contributions from individuals are deducted by the individual's employer, from his or her salary before tax is calculated. It’s worth noting that although the pension contribution doesn’t therefore get taxed, National Insurance will still apply on the gross salary. 

For example, where an individual wants to pay £1,000 gross the employer would deduct the full amount from salary and pass it to the pension scheme as the individual's £1,000 gross contribution.

In this way, the individual receives tax relief immediately and directly through his or her salary. National Insurance is still payable on the full salary though.

In contrast to net pay, contributions paid under relief at source do not reduce the individual's earnings before tax is calculated. The individual's earnings will be subject to deduction of tax in full.

Relief at source

Used by non-occupational pension schemes such as personal pensions, stakeholder pensions and group personal pensions.

Contributions by individuals and third parties are paid net of basic rate tax relief to the scheme and the scheme administrator claims basic rate tax relief from HMRC, which is paid directly into the scheme.

So for every £800 net paid by the individual / 3rd party, HMRC adds £200 to make £1,000 gross.

If the individual is entitled to a rate of tax relief above the basic rate he or she must claim this from HMRC via self-assessment. It’s important to remember that members will only get a rate of relief above basic rate for any taxable income above the basic rate. For instance a member with £1,000 of earnings in the higher rate of tax paying £5,000 gross into a pension scheme operating RAS would only be able to reclaim higher rate relief for the £1,000 that is in the higher rate band of tax.

It can take perhaps up to 10 weeks for the provider to receive the basic rate tax relief from HMRC. However, many schemes / providers will usually gross up the contribution immediately at the time the net contribution is received.

Assessment – claim to HMRC

A claim must be made to HMRC:

  • for contributions paid to retirement annuity contracts ('s226')*
  • for higher and additional rate tax payers paying contributions via PIRAS (pensions income tax relief at source), relief at source and
  • where a member of a scheme operated on the net pay basis wants to pay a contribution that cannot be supported by the earnings in the pay period – eg a single contribution at the end of the tax year.*

*Please note that for members with no taxable earnings (i.e. within the personal allowance) no further claim can be made to the revenue, the only way to obtain tax relief for these members would be a payment to a relief at source scheme.

Comparison of tax relief using each method

  Relief at source  Net pay/Make a claim 
Taxable earnings over personal allowance
Less gross contribution
Tax due at 20%

£1,000
0
£200

£1,000
£2,000
0 (£200 saved here)
Net contribution/ cost from take home pay
Plus tax relief
Total Pension Pot

£1,600
£400
£2,000

£1,800
£0
£2,000

The difference is, using RAS there is an additional £400 added to the member’s pension plan even though the member’s tax bill was only £200. Using Net pay/ make a claim, there is no additional tax relief from HMRC over and above the £200 saved by the contribution increasing the personal allowance by £1,000.

Level of tax relief

Tax relief is available on the following contributions:

  • individuals with earnings chargeable to UK income tax or who are resident in the UK – the greater of £3,600 gross and 100% of UK earnings
  • non-UK resident individuals with no relevant earnings - £3,600 gross.

The £3,600 amount is known as the 'basic amount'. Due to the way tax relief operates those with lower earnings / no earnings can only make use of the £3,600 if paying to a scheme that operates relief at source.

Basic rate tax relief

Anyone under 75 can benefit from basic rate tax relief on some or all of the contributions they pay, regardless of whether or not an individual actually pays any income tax.

Where an individual is restricted to tax relief on £3,600 – either because they are non-UK resident or have earnings below £3,600 – they will be able to receive basic rate tax relief in full on the gross contribution only if the pension scheme operates relief at source.

Higher and additional rate tax relief

Higher and additional rate taxpayers are entitled to tax relief at their highest marginal rate of tax. This does not necessarily mean that an individual will receive higher or additional rate tax relief on the whole of the contribution.

The tax relief is limited by the amount of an individual's income that falls within the higher or additional rate tax bracket.

For schemes operating relief at source, the additional tax relief is given by extending the basic and higher rate tax bands by the amount of the gross pension contribution (ie the individual's net contribution plus the basic rate tax relief paid to the scheme by HMRC).

The thresholds may only be extended by up to 100% of the members relevant earnings.

Some example calculations

Example 1 – client lives in England

  • Additional rate taxpayer
  • Gross pension contribution - £10,000

Under relief at source, the overall tax position would be:

 

In this scenario, the impact of the pension contribution is that it removes the member from the additional rate band.

Example 2 

  • Higher rate taxpayer who lives in England
  • Gross pension contribution – £20,000

Under relief at source the overall tax position would be:

Example 2 - Tax Relief Members Contributions

In this scenario, the impact of the pension contribution is that it removes the member from the higher rate band.

Self-employed

As mentioned earlier, for self-employed individuals, their relevant earnings are profits calculated over their chosen period of account.  This does not need to align with the tax year ie 6th April to 5th April. 

Period of Account vs relevant earnings

Although it’s possible to have a period of account that runs for less, or more, than 12 months and to change the year end date if required, it is common for it to run for 12 months, eg 1st April to 31st March, or 1st January to 31st December. Apart from special rules for the opening years and when the accounting date is changed, once the amount of profit is known, it’s assessed for tax in the tax year in which the accounting period ends.  So profits for a period from 1 April 2019 to 31 March 2020 will be assessed against the tax rates applicable for tax year 2019/20. The amount of taxable profit is the relevant earnings figure to support pension contributions paid in the 2019/20 tax year (ie between 6th April 2019 and 5 April 2020).

Tax relief in excess of basic rate

For pension contributions paid to a Relief At Source (RAS) scheme, we know that any tax relief in excess of basic rate needs to be claimed through self-assessment. For self- employed individuals making their own contributions, additional relief is gained when the balancing payment for the tax year is made.  As you’d expect, and in line with the usual self-assessment tax deadlines, this is due on 31st January following the end of the relevant tax year.

The self-employed make two payments on account of income tax plus a balancing payment.  The due dates are 31 January during the tax year, then 31 July with the balancing payment on 31st January after the tax year.  The first two payments are usually half of the previous year’s income tax liability less any amounts of tax paid by deduction at source. This means any higher or additional rate tax relief due for a pension contribution paid in the tax year will normally be taken in to account with the balancing payment.

Scenario and worked example

Cynthia lives in Liverpool and has been a self-employed statistician for the last 10 years. Her accounting period ends 31st March each year, so her next set of accounts will be for the period 1st April 2019 to 31st March 2020. She expects to make profits of £60,000 and intends to make a personal contribution of £12,500 gross.  The maximum contribution for tax relief would be 100% of relevant earnings ie £60,000 gross providing it was paid before 5 April 2020.     

Cynthia pays a pension contribution of £10,000 net on 17th March 2020.  The provider claims RAS of £2,500 from HMRC and invests £12,500 gross in Cynthia’s pension plan. Let’s look at Cynthia’s total tax liability before and after making the pension contribution.

Before pension contribution After Pension Contribution
Taxable profit £60,000
Taxable profit
£60,000
Deduct personal allowance £12,500 Deduct personal allowance
£12,500
Balance £47,500
Balance
£47,500
Basic rate band £37,500
Basic rate band
£50,000
Tax liability   Tax liability
 
Basic rate £37,500 @ 20% £7,500 Basic rate £47,500 @ 20% £9,500
Higher rate £10,000 @ 40% £4,000    
Total tax liability £11,500 Total tax liability £9,500

Cynthia’s total tax relief is £4,500, made up of £2,500 RAS and £2,000 (£11,500 - £9,500) at the higher rate. The effective rate of tax relief is 36% (4,500/12,500 x100). Prior to making the pension contribution, Cynthia only had £10,000 of earnings subject to higher rate tax and this has capped the higher rate relief available.

Timings for paying income tax

For the self-employed, payments on account are usually based on the previous year’s tax liability. Whilst the first two payment instalments are unlikely to be affected by current year pension contributions, any reduced tax liability will become clear in the final balancing payment and will impact next year’s tax payments.

Let’s say Cynthia’s tax liability for 2018/19 was £8,000, this means her payments on account for 2019/20 would be:

31st January 2020 - £4,000

31st July 2020 - £4,000

As shown above, had Cynthia not paid her pension contribution in tax year 2019/20 total tax due is £11,500.  This would have meant a balancing payment of £3,500 (£11,500 - £4,000 - £4,000) due on 31st January 2021. But by making the pension contribution, this reduces the balancing payment to £1,500.

Moving forward to tax year 2020/21, if the £12,500 pension contribution had not been paid, this would have meant payments on account of £5,750 each (£11,500/2).  However as the pension contribution was paid, this reduces those payments to £4,750 each (£9,500/2), with any shortfall being picked up in the balancing payment due on 31st January 2022.

As demonstrated, as well as the usual benefits of reducing their actual tax bill and building up a retirement pot, for the self-employed, the timing of paying pension contributions can reduce future payments on account and balancing payments which could also help with their cash-flow.

Other issues

 

Annual Allowance

 

Annual allowance, including money purchase and tapered annual allowance

These are covered fully in our Annual Allowance, Money Purchase Annual Allowance (MPAA) and Tapered Annual Allowance (TAA) articles. Although the annual allowance rules don’t directly impact on the tax relief given on pension contributions, they do impact on the effective rate of tax relief by the application of an annual allowance charge. Tax relief is given in full and claimed on the self-assessment in the usual manner. However, where the annual allowance (or MPAA/ TAA) is breached there will be a separate charge which will clawback some of the relief gained. 

Excess contributions paid in error

Where an individual mistakenly contributes more than 100% of earnings or £3,600, (if relevant earnings are lower), for example a self-employed person who cannot be sure of their total profits for the year, it is possible to claim a refund of contributions paid that were not eligible for tax relief – ie the excess over the greater of 100% of earnings and £3,600. The rules of the scheme will determine whether the refund is allowed or not.

The individual can claim a refund within six years of the end of the tax year in which the contributions were made.

The refund is called a refund of excess contributions lump sum.

PTM045000

Error payments

Where an individual or an employer makes a payment to a pension scheme that is returned to them, it may constitute an unauthorised payment.

An error payment is a payment that the scheme has no right to hold and is therefore neither an authorised payment nor an unauthorised payment, ie it’s not a pension contribution within the meaning of the Taxes Acts / Finance Act.

In this case, the error payment (gross) may be returned to the employer without it being treated as an unauthorised payment. The following are examples of valid error payments given by HMRC:

  • the scheme only provides for contributions to be made while the member is in service of the relevant employer,
  • any payment made after the cessation of the member's employment, where the terms of employment set out that contributions cease upon cessation of employment,
  • failure of a bank/building society to cancel a standing order/direct debit after being instructed to do so, or
  • where an employer incorrectly calculates the pension contribution or deducts the wrong rate of contribution under the scheme rules.

If the employer has obtained tax relief to which it is not entitled to receive, they must rectify this.

HMRC also allow a refund of contributions where membership of a policy / scheme has been cancelled within the 'cooling off' period specified by the appropriate regulatory body. In this case, prior approval from HMRC is not required.

Finance Act 2004 -
Section 188 (Relief for contributions)
Section 189 (Relevant UK Individual)
Section 190 (Annual limit for relief)
Section 191 (Methods of giving relief)
Section 192 (Relief at source)
Section 193 (Relief under net pay arrangements)
Section 166 & Paragraph 6 Schedule 29 (Refund of excess contributions lump sum) 

Labelled Under:
Pension contributions

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