Tax relief at the basic rate of 20 per cent is applied, at source, to personal/employee contributions made into personal pensions (including GPPs and SIPPs, of course).
For example, a client with an income of £45,000 plans to make gross annual contributions of £10,000 into a Group Personal Pension. By gross contributions we mean the total planned contribution, inclusive of any tax relief that is applied. The software will apply tax relief at source to this gross contribution, resulting in an individual contribution form their employment of £8,000, paid from post-tax income, accompanied by 20% basic rate tax relief at source ('unscheduled' contribution) of £2,000 for a total pension contribution of £10,000.
Higher rate tax relief is granted by extending the basic and higher-rate tax bands by the value of the gross contribution, with the effect that the investor gets higher rate relief by paying basic rate tax on income which would, otherwise, have been subject to higher rate tax.
In the illustration, above, the individual only has £35,000 of taxable income but the basic rate tax band is extended (up to or less than the £12,500 contribution) with the effect that no tax is paid at the 40% rate.
Categories of Money Purchases Ineligible for Tax Relief at Source
Not all categories of money purchase scheme receive tax relief on contributions at source. There is an alternative way to receive tax relief on contributions, known as the 'net pay arrangement', the basis on which most occupational schemes are operated. This is only applicable where personal/employee contributions are deducted, through payroll, by the employer. Under this method, contributions are assumed to have been taken from the member’s pay before tax is calculated, with the effect that they have been given full tax relief at their highest marginal rate. Within the software, tax relief on contributions to COMP/CIMP schemes (grouped together in the 'Occupational Pension' category) and to Small Self-Administered Schemes (SSAS's) is applied in this manner.
Rebate-only personal pensions, of course, are not eligible for tax relief since they do not receive personal contributions.
Whenever employer contributions are being made these should (also) always be entered as a gross amount and they will be identified by the software as an 'unscheduled' contribution, as illustrated below:
In this instance, the 'unscheduled' contribution comprises £2,000 of basic rate tax relief and a gross employer contribution of £4,500 (10% of salary).
Where to View Tax Relief
Each of the above screenshots, showing the presentation of pension contributions and tax-relief, is taken from the Pension and Taxes sections of 'Year View' view, found from the Let's See or Dashboard charts.