From Employed to Self-Employed: Tax Relief on Pension Contributions

Employed: Tax Relief on your Pension Contributions

Typically, when an individual is in employment, they will make regular pension contributions to an occupational pension scheme. This is usually dealt with entirely through the payroll of the employer.

Tax relief on contributions to an occupational pension scheme is obtained by way of a ‘net pay arrangement’.

This is where an employee’s pay, after deduction of occupational pension contributions, is subject to PAYE. Therefore, the more an employee contributes to the pension scheme, the less tax will be deducted under PAYE.

For example, a basic rate taxpayer who contributes £1,000 to an occupational pension scheme, will actually only receive £800 less in their take-home salary for the month. This is because they will have paid £200 less income tax via PAYE as a result of the reduction to their taxable income.

As tax relief is given via the PAYE system, the correct rate of tax relief will always be obtained, depending on whether the individual is a basic, higher or additional rate taxpayer.

However, not all employment pension schemes operate via a ‘net pay arrangement’ and it is important to check whether pension contributions are deducted from your gross salary, or from your net salary, after the deduction of tax from the contributions. If it is the latter, which is usual for “auto-enrolment” schemes, a higher or additional rate taxpayer may be able to claim an income tax refund, in the same way as a self-employed person described below.

Self- Employed: Tax Relief on your Pension Contributions

When an individual makes contributions to a personal pension, tax relief is obtained in a similar manner to the second scenario described above for employees.

Relief is provided under the term ‘relief at source’. This means that if an individual wants to contribute £1,000 to their personal pension, they will only contribute £800 and HMRC will make up the additional £200.

If the individual is a basic rate taxpayer, the correct amount of tax relief has already been obtained, by way of the 20% contribution to the pension scheme by HMRC.

If, however, the individual is a higher or additional rate taxpayer, tax relief is obtained via their self-assessment Tax Return. This is given by extending the basic rate tax band by the gross pension contribution made by the individual.

Going back to the previous example, a net contribution of £800 would extend the basic rate tax band by £1,000, meaning £1,000 of income would be taxed at the basic tax rate, instead of at the higher or additional tax rate, thereby achieving the correct tax relief for that individual.

How will maximum annual contributions impact me?

It is important to note that the maximum contributions that an individual can obtain tax relief on in any tax year is restricted to 100% of their ‘relevant earnings’. This is made up of employment and trading income, income from furnished holiday lettings and some patent income.

Any individual, regardless of the level of their earnings, can contribute up to £3,600 per year to a pension scheme and obtain tax relief on this. This is the gross pension contribution figure after the addition of the 20% tax relief, the amount actually paid being £2,880 per year, or £240 per month.

What is the Annual Allowance?

There is a further restriction on the amount of pension contributions that can be made in any tax year, known as the ‘annual allowance’. The annual allowance for 2023/24 is £60,000, which is the standard maximum amount of gross contributions that can be paid in the year. This amount, which includes contributions made by the employer, can be reduced where an individual earns over certain thresholds.

You will have a ‘tapered’ annual allowance if your “threshold income” is over £200,000 and your “adjusted income” is over £260,000, for the 2023/24 tax year.

Any excess pension contributions over the annual allowance will incur a tax charge, at the taxpayer’s marginal rate.

Payments in a year can be increased by unused annual allowances for the previous three years.

This can be a complex area of taxation and if you are in any doubt, professional advice should be sought.

If you would like to discuss the tax reliefs available for pension contributions in more detail, please get in touch with our Tax Team. Please note however that we are unable to advise on the type of funds which your pension fund is to be invested in.

Author: Louise Berry, Tax Manager

Any views or opinions represented in this blog are personal, belong solely to the blog owner and do not represent those of Plus Accounting. All content provided on this blog is for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site.

Date published: 31 May 2023

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