Tax advice of the week: Maximise your pension tax relief
Feb 20, 2012
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Many higher-rate taxpayers fail to maximise tax relief on their pension contributions because they don’t understand how it is calculated, says Nick Braun in Business Tax Saver.
The maximum higher-rate relief you can claim is your “gross pension contribution x 20%” and you can only claim it if you have at least this much income taxed at 40%. To maximise your relief, you must ensure your gross contributions do not exceed the amount of income you have taxed at 40%.
Take Sandy, who earns £50,000. He has £7,525 of income taxed at 40% (£50,000 - £42,475). He puts £15,000 into a pension; HMRC adds £3,750 of basic-rate relief, making his gross contribution £18,750. But since Sandy only has £7,525 taxed at 40%, he can only claim £1,505 of relief (£7,525 x 20%) and loses out on £2,245 of higher-rate relief (£18,750 -£7,525 x 20%).
Spreading his contribution over several years would avoid this. To maximise relief, make a gross contribution of no more than “your taxable income minus £42,475”. Multiply this by 0.8 to obtain the maximum amount you can invest.