Personal Contributions and Tax Relief Background
When an individual pays a personal contribution to a pension scheme, they will normally be entitled to tax relief on the payments that they make. This means that the contribution will usually benefit from an associated payment being made by HM Revenue & Customs (HMRC) into the pension fund of the individual – either directly in the form of a physical payment of money, or indirectly in that the payment is made before the deduction of income tax. There are, however, a number of conditions that need to be met before an individual can obtain tax relief.
Personal Pension Contributions and Tax Relief Summary
- Contributions are paid by individuals net of basic rate tax. This means that an individual pays 80% of the total amount they wish to put into the pension. The balance is reclaimed from HMRC.
- For an individual to be able to obtain tax relief they need to be an active member of a registered pension scheme, and a relevant UK individual in the tax year in which the contribution is paid.
- There are two principal methods of obtaining tax relief: net pay arrangement, and relief at source. The former is a method where an employer deducts the amount from salary prior to taxation. Relief at source involves the payment of the net amount followed by a reclaim from HMRC.
- Personal Pension Schemes, including SIPPs, cannot operate the net pay arrangement. This means that when individuals redirect contributions to SIPPs from employer schemes, they must ensure that any member contribution is arranged on a relief at source basis.
- Higher rate taxpayers need to claim additional tax relief between their basic and marginal rate using self assessment.
Relevant UK Individual
Broadly, a relevant UK individual must have relevant UK earnings chargeable to income tax for that tax year; be resident in the UK at some time in that tax year; were resident in the UK at some time during the five tax years immediately before the tax year in question; and were resident in the UK when they joined the Scheme. Relevant UK earnings is in essence employment income (salary, wages, bonus, overtime etc), and income derived from the carrying on of a trade, profession or vocation.