The maximum amount of contributions on which a member can claim relief (up to their available annual allowance) in any tax year is the greater of:

• the ‘basic amount’ – currently £3,600, and
• the amount of the individual’s relevant UK earnings that are chargeable to income tax for the tax year.

Personal pensions that are run on a “relief at source” basis (including the Skandia personal pension and Collective Retirement Account) will give basic rate relief within the pension scheme. If an investor pays £80 net, the scheme administrator will invest £100 into the personal pension and claim the £20 tax relief back from HMRC on behalf of the investor.

A higher rate tax payer will be entitled to another £20 of higher rate relief (or £30 if they pay tax at 50%). This is claimed by the investor through their Self Assessment or by sending a letter separately to their tax office.

Tax relief is not available for employer contributions which are paid gross. The employer may be able to offset the pension contribution as a business expense against their corporation tax bill.

Higher rate tax relief works by increasing the thresholds upon which an investor pay basic and higher rate tax by the amount of gross personal pension contribution paid. This is detailed in Income Tax Act 2007 part 2 chapter 3 and FA 2004 section 192 (4).

Example 1

Take an individual earning £62,475 who would normally be paying 20% tax on the next £35,000 of income, after personal allowance, and 40% on the next £20,000: the individual paid a £20,000 gross personal pension contribution this would push the basic rate band up to £55,000 (after personal allowance), meaning that the individual now pays tax at 20% on all income and no longer pays any higher rate tax. The individual receives higher rate tax relief, by not paying higher rate tax.

So here the individual received 20% relief through self assessment and the other 20% relief is received at source through the pension provider by paying a net contribution and seeing it grossed up within the scheme, giving them a total of 40% on the full £20,000 contribution.

Example 2

Example 3

Both basic and higher rate thresholds increase by £10K. This effectively replaces some of the higher rate with the equivalent increase in the basic rate. They therefore receive 30% relief. Adding that to the 20% gross up by the provider gives 50%.

Personal allowance is £7,475

Basic rate of 20% tax on income up to £35,000
Higher rate of 40% on income between £35,001 and £150,000

Additional rate of 50% on income over £150,000

Calculation for example 2

Calculation for example 3

*In this example client has no personal allowance left as the allowance is reduced by £1 for every £2 of income over £100K.

The client has received the full 50% tax relief on a £10,000 gross personal contribution to a personal pension.

Tax relief given is a combination of paying £3,000 less tax on their income, together with the £2,000 of tax relief granted within the pension scheme, giving them total tax relief of £5,000 on a £10,000 contribution.

There is an alternative way to receive tax relief on pension contributions known as the “net pay arrangement”. This is only applicable where personal contributions are deducted through payroll by the employer. As the contribution is taken from the member’s pay before tax is calculated they have effectively been given full tax relief. It is not possible for a personal pension scheme to be run on this basis.

Most occupational schemes will operate on the “net pay” basis.