When sitting down to complete your annual self-assessment tax return, it’s easy to think of the words of comedian Chris Rock: “You don’t pay taxes – they take taxes.”
If you’re a higher- or additional-rate taxpayer, there is one easy way to avoid HMRC “taking” quite as much tax from you. That’s to ensure you claim the tax relief that you’re entitled to on your pension contributions.
Despite the significant financial benefits of claiming 40% or 45% tax relief, new research has revealed that 8 in 10 higher-rate taxpayers are failing to claim their pension tax relief through their self-assessment tax return.
The costs of this mistake could end up being significant over time. So, read on to find out more about this new research, how pension tax relief works for higher earners, and why it’s so important for you to claim the relief you’re entitled to.
How pension tax relief works for higher- and additional-rate taxpayers
If you’re a basic-rate taxpayer and you’re employed, it’s likely that your tax relief is claimed automatically on your behalf.
Most basic-rate taxpayers benefit from “relief at source”, which requires pension providers to claim basic-rate tax relief of 20% on behalf of their customers and put it in their pensions.
If you’re a higher- or additional-rate taxpayer, you have to claim the additional 20% or 25% relief from HMRC. You will normally do this through your annual self-assessment – even if you’re employed.
Claiming this additional tax relief is hugely beneficial. As a higher-rate taxpayer it means that every £1,000 contribution to your pension only costs you £600, with the rest coming in the form of tax relief.
Make sure that you state the exact amount of your pension contributions when you file your self-assessment return each year. This should be a gross calculation that includes your contributions and the basic-rate tax relief of 20%.
Your tax relief will come as:
- A change to your tax code
- A rebate at the end of the year
- A reduction in your tax liability.
As an alternative to self-assessment, you can write to your tax office outlining the pension contributions you have paid. You will have to submit a new letter every time you change your pension contributions.
Thousands of taxpayers failing to claim their tax relief
Despite the substantial financial benefits of claiming tax relief, new research published in Pensions Age has revealed that many thousands of people are not claiming their additional relief.
The study showed that an average of 80% of higher-rate taxpayers eligible to claim relief through their self-assessment tax returns failed to do so between 2016 and 2019, alongside an estimated 53% of additional-rate taxpayers.
The figures, obtained via a freedom of information request to HMRC, showed that more than 1.5 million of the UK’s highest earners failed to claim an estimated £810 million in tax relief in the 2018/19 financial year. Over this and the previous two financial years, higher-rate taxpayers failed to claim around £2.3 billion.
Additional rate taxpayers, meanwhile, overlooked a total of £164.7 million in the same three-year period.
How much it might cost you if you don’t claim your additional relief
Here’s an example to showcase just how much you could be missing out on if you don’t claim the additional pension tax relief you’re entitled to.
You earn £100,000 a year and make a £20,000 contribution to your pension. The provider collects basic-rate tax relief at source, adding £5,000 to your pension pot. You could then claim an additional £5,000 in tax relief through your self-assessment tax return.
In simple terms, if you don’t claim your tax relief in this example, it costs you £5,000.
However, it’s not just the £5,000 you’d potentially miss out on. If that money was invested for 20 years, and achieved an annual return of 4%, it would be worth £10,955 at the end of the 20 years.
If you failed to claim the same £5,000 tax relief every year for 20 years (assuming an annual return of 4%), your pension pot would be £159,000 smaller when you came to retire.
(Figures using calculator.net)
Earn over £200,000? Don’t forget the Tapered Annual Allowance
If you pay additional-rate tax, the amount of tax relief you can receive may be affected by the Tapered Annual Allowance.
In the 2021/22 tax year, the Annual Allowance restricts the tax-efficient contributions you can make to your pension to £40,000.
However, if your “threshold income” is over £200,000 in a year, or your “adjusted income” (threshold income plus all pension contributions) is more than £240,000, you may be affected by the taper.
Under the taper, your Annual Allowance is reduced by £1 for every £2 of adjusted income you earn above £240,000. So, if you earn £312,000 or more, the full taper will kick in and leave you with an Annual Allowance of just £4,000.
The table below shows how the Annual Allowance tapers, based on your earnings.
If you earn more than £200,000, you could well be affected by the Tapered Annual Allowance. So, it can be beneficial to work with a financial planner who can establish the most tax-efficient ways to plan for your retirement.
Get in touch
If you’re concerned that your pension contributions are not as tax-efficient as they could be, or you think you are missing out on valuable tax relief, please get in touch. Email email@example.com or call 020 7467 2700.
If necessary, we can also introduce you to a tax adviser who can help you save both tax and time.
This document is marketing material for a retail audience and does not constitute advice or recommendations. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amount originally invested.