Keep calm and claim tax relief

The recent turmoil caused by the now-notorious not-so-mini-Budget, and the subsequent U-turns have not only played havoc with the markets, but also any pension geek trying to work out the implications of tax relief. I’m quite sure it’s not been the calmest of periods for advisers either.

Since 23 September I’ve looked at the impact of additional rate tax being cut, how carry forward could be used to maximise tax relief before the axe, considered the impact of having relief at source paid at a different rate to basic rate tax actually paid for a year, looked at the winners and losers under net pay, and contemplated all the scenarios north of the border if Scottish tax stayed constant when rest of the UK changed.

And here we are back to the start again.

Whilst frustrating, it has been interesting to think through the implications and connotations, and three key points stuck out for me.

Tax relief

The underlying concept of tax relief on personal pension contributions is that you get back the tax you have paid. So, whatever the rate of tax you pay it will cost you the same amount to get it into your pension. If you have £1,000 gross income that you pay 20% tax on, you get £800 and put it into your pension, and you get £200 tax relief to end up with £1,000 in your pension. If you pay 19% tax you get £810, pay it into your pension and you end up with £1,000 in your pension too, you’re no better or worse off. Someone paying 45% tax puts the same £800 in with 20% relief at source to have £1,000 in the pension, but they get back £250 from HMRC, so the net cost is £550. If relief at source was 19% they pay in £810 initially but get back £260 so end up in the same position. The key point here is pension contributions make sense for tax relief purposes whatever the rate.

Salary sacrifice

Of course, it’s not just Income Tax that has had numerous changes. We’ve also seen changes to National Insurance (NI) and the proposed introduction, followed by scrapping, of the Health and Social Care Levy (HSCL). Both of these can/could have been avoided with salary sacrifice. You know this already but looking at this again has reminded me of the benefits of sacrificing salary in favour of employer contributions, rather than making personal pension contributions. Both employer and employee save on the NI. Conversations about recent changes can be a useful prompt for discussions for those not already using salary sacrifice.

Net pay

Net pay schemes work well for higher earners, and in Scotland that will include anyone paying the 21% intermediate rate of Income Tax, not just higher and additional rate taxpayers.

Under net pay full tax relief is granted automatically, without the need to complete a self-assessment or contact HMRC. However, it fails anyone earning below the personal allowance as they miss out on the 20% tax relief they would get if they were paying into a relief at source scheme. After years of these people losing out, plans have finally been put in place in an attempt to resolve this. However, the first claims cannot be made until 2025/26 relating to the 2024/25 tax year. It also looks like lower-paid employees will have to take action to claim the extra tax relief, unlike it happening automatically under relief at source schemes. This of course means there are likely to be many that do not bother, especially when you consider these are likely to be some of the least engaged pension savers.

Ideally the net pay remedy would be a more automated system and brought in earlier, because it is those that need help the very most that are losing out, not just on the tax relief itself but also on the compounding effect which we know is so very valuable.