Do you get basic rate tax relief (20%) or higher rate tax relief (40%) on your pension contributions?
In this post I’ll explain how to blow those figures out of the water and get 150%+ uplift on your pension contributions!
In the UK, basic rate tax relief on pensions is 20%. This means non-tax payers and basic rate taxpayers actually get a 25% uplift in their pension contributions. So if you contribute £1000 as a basic rate taxpayer you have a total of £1250 in your pension.
Higher rate taxpayers get 40% tax relief, which is equal to a 66% uplift. So if you contribute £1000 you get a total of £1666 in your pension.
However, there is another hidden way to get 150%+ uplift on a portion of your pension contributions, even for basic rate taxpayers.
So, what is this hidden way, and how can we take advantage of this perk?
We are talking about Tax Credits, and the relatively unknown fact that pension contributions reduce the income figure used to calculate your entitlement.
If you don’t already claim tax credits you may have to act quickly as the system is being changed to universal credit, and already has been in some areas. Different rules apply to universal credit.
Tax credits can literally be worth thousands of pounds, although the system is quite complex.
Who can get tax credits?
Tax credits are not just for people with kids.
There are two types of tax credit – child tax credit and working tax credit.
Single people and couples aged over 25 with no kids can claim working tax credits providing they are working over 30 hours per week in total.
Single people and couples with kids can claim child tax credit and working tax credit.
Aren’t tax credits just for low earners?
Not necessarily, as we can use pension contributions to reduce the income figure used to calculate tax credits.
However, for singles/couples without kids and higher earners quite large pension contributions may be needed to reduce applicable income.
Who might take advantage of this perk?
It’s quite complicated, so I’ll try to illustrate who it could apply to, using a couple of examples/scenarios.
Example 1 – Single person over 25, working 30+ hours/week, no kids
The cut-off point for this person to claim tax credits is £13253.00. If they earned over this figure then pension contributions could be made to reduce their income used to calculate tax credits.
For every £1 reduction in income below this, to a minimum of £6420.00, the amount of tax credit paid is £0.41.
So if a person earning £13253.00 contributed £6833.00 gross (£5466.40 net) to a pension they would receive the maximum tax credit of £2770.00.
In reality then, a £6,833.00 gross pension contribution has actually cost them £2,696.40 (£5,466.40 – £2770.00). An effective uplift of 153%.
Example 2 – A couple over 25, working 30+ hrs combined, no kids
Cut off point £18023.00
Maximum tax credit available is £4780.00.
Maximum pension contribution is £11603.00 gross (£18023-£6420)
Effective cost of max contribution £11603 x 0.8 = £9282.40 net – £4780.00 = £4,502.40
Effective uplift of 157%
Example 3 – Couple with 2 children, working 30+ hrs, 2 kids
Cut off point £32988.00
Maximum tax credit available is £10885.00
Maximum pension contribution is £26,568.00 gross
Effective cost of max contribution £26,568 x 0.8= £21254.40 net – £10885.00 =£10369.40
Effective uplift of 156%
Everyone’s circumstances are different and therefore the above are only illustrations of how it is possible to get extra effective tax relief on pension contributions by utilising tax credits.
Supercharging your pension in this way would require large pension contributions that maybe a lot of people would not be able to afford.
Just hope this post has brought something to your attention that is not widely known.
Were you aware of this and is it something you would consider?
Comments appreciated as always.