February 27th, 2020
How to get tax relief on pension contributions (for high earners)
It’s not always simple, but it is completely possible to get tax relief on pension contributions for high earners. Here’s a quick explanation.
More money, more tax problems?
The opportunity to earn a lucrative salary is something many aspire to, and something you can feel rightly proud of. But there’s nothing like a healthy income to bring unwanted complexity to your tax affairs. And tax tends to get more complicated, not to mention costly, as your earnings go up.
High earners often find their personal allowance – the amount of income you are allowed to earn before paying income tax – is reduced to rubble. In fact if you earn £125,000 or more, you’re not entitled to any personal allowance at all (2020/2021).
That can leave you giving away a lot of your hard-earned income to the taxman – up to 45% of it. But when you make smart use of your annual pension contribution allowance, you can reduce your tax liabilities while working to make sure your financial future is as comfortable as your present. So how does it work?
Get tax relief on your pension contributions
The government wants people to save for their future. So to encourage pension contributions, they provide tax incentives. The way it works is simple: you get tax relief on your pension contributions at the highest rate of tax you currently pay. That means higher rate taxpayers can get 40% tax relief on their pension contributions, while additional rate taxpayers can claim 45% pension tax relief.
So far, so good. But how does that help you keep more of your money?
Thanks to the tax incentives, higher rate (40%) and additional rate (45%) taxpayers only need to effectively contribute £60 and £55 respectively to achieve £100 worth of pension savings. Read that again: you can ‘buy’ £100 towards your future with as little as £55.
When you add in the fact that your tax-free pension contribution allowance could be as high as £40,000, it’s easy to see how you could make significant tax savings by paying into your pension.
Reclaiming the tax on your pension contributions
High earners that are self-employed can reclaim tax through self assessment. (Your pension provider will claim 20% tax within the pension itself, before you claim the additional 20-25% through your tax return.)
If your contributions are made via an employer or your own limited company, the contributions will almost always be made for you before tax is deducted. That means you get the tax relief at source, so there’s nothing further to claim.
A word of caution
It’s possible to make significant tax savings by diverting money into your pension. But don’t overdo it. If you go over your annual allowance for pension contributions, anything you put in over the threshold will be taxed at your nominal rate. That defeats the purpose of using your pension as a vehicle to reduce your tax liabilities while saving for your future. If you would like help working out your annual pension contribution allowance, talk to us.
Make your money go further
It’s no secret that tax gets more complicated as your earnings increase. That makes it harder to know whether you are making the right decisions for both your financial present as well as your financial future. Our talented financial advisers help high earners make sense of their financial landscape and find ways to make best use of their wealth. Get in touch and let’s have an informal discussion about how we could help you.
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