Chapter 5: Policyholder taxation, Pension contracts Are the following numerical examples correct? Individual is a 40% tax payer Example 1 A total of £35,000 has been contributed into the individual's pension in one year. This is split as follows: £5,000 paid by individual, £30,000 paid by employer Tax relief (@ 40%) is received on: £3,600 (personal allowance) + £30,000 (as have not reached annual allowance) = £33,600 And so the remaining £1,400 is taxed at 40%. Example 2 A total of £41,000 has been contributed into the individual's pension in one year. This is split as follows: £5,000 paid by individual, £36,000 paid by employer Tax relief (@ 40%) is received on: £3,600 (personal allowance) + £36,000 (as have not reached annual allowance) = £33,600 And so the remaining £1,400 is taxed at 40%. Example 3 A total of £50,000 has been contributed into the individual's pension in one year. This is split as follows: £3,000 paid by individual, £47,000 paid by employer Tax relief (@ 40%) is received on: £3,000 (less than personal allowance) + £37,000 (remaining of annual allowance) = £40,000 And so the remaining £10,000 is taxed at 40%.
The first rule for pension contribution is that: "Individuals can obtain tax relief on contributions up to £3,600 per annum or their full taxable UK earnings if higher." Let's assume that the full earnings are higher than the total (individual and employer) annual contributions. The relief will be on the contributions paid by the individual. Therefore they will not pay any tax on the £5,000 as their full earnings are higher. The second rule also considers the employer's contribution - The annual allowance. In the above example, the annual contribution is less than £40,000, so tax relief is still applicable. As in the first example, the first rule is met (if we assume full earnings are higher than the total annual contributions). However the second rule has not been met. This means that £1,000 (£41,000-£40,000) will not be entitled to tax relief. Similar, to the previous examples, £10,000 (£50,000-£40,000) will not be entitled to tax relief. Hope this helps. Thanks Em
Hi Em So the lower one's earnings, the lower the contribution amount on which tax relief can be obtained? I'm trying to understand the significance of the £3600.
Yes, that's right: the lower the amount that you earn, the lower the amount that you can pay (tax-free) into your pension. It is basically capping tax-free pension contributions at the total amount that you earn during a year. This should make sense: it is reasonable not to allow someone to invest (with tax advantage) an amount each year which is more than they actually earn (i.e. the amount that they have paid tax on). The £3,600 cuts in at lower income levels. If you earn less than £3,600 (including earning nothing) then you are allowed to contribute up to £3,600 tax-free into a pension. For example, a parent could start a pension plan for a child and would be allowed to pay up to £3,600 a year into that pension, obtaining tax relief on that amount.
