I’m likely to become a higher rate taxpayer this financial year. If I choose to pay into a SIPP for the tax benefits, how much do I need to invest to reduce my taxable income by £100. Is it £100 or £80?  Also how do I then claim the tax back to allow for the 40% rate I will have paid on that £100? 

Michael

Rachel Vahey, AJ Bell Head of Public Policy, says:

A few months ago, the Office for Budget Responsibility forecasted that the amount the UK is set to pay in income tax in 2027-28 will hit £310 billion.

Since the tax thresholds were frozen in 2021-22, millions more people have seen their income breach the next tax threshold, boosting the UK’s tax take.  So, it’s safe to say that you will not be alone in becoming a higher rate taxpayer this year.

One way to reduce your taxable income, to ‘dip under’ that higher rate tax threshold, is to make a pension contribution.

REMINDER ON TAX RELIEF

As a reminder, if you pay into a SIPP, then your personal contribution will be topped up with 20% basic rate tax relief. This money is added direct to your pension. For example, if you pay an £80 contribution, HMRC will pay in £20 on top of that, making a total of £100 contribution. Your pension provider will organise for HMRC to make that payment in – you don’t have to do anything.

If you pay more than 20% tax on some of your earnings, you can reclaim extra tax relief through your self-assessment. But if you don’t usually complete one, you can still claim it by completing an online form from HMRC or contacting HMRC directly. Any extra relief will be returned to you or reduce your tax bill for the year – it isn’t paid into your pension.

You will only get extra tax relief to the extent you pay a higher rate of tax.

As I said above, paying a pension contribution can be particularly advantageous if the level of your earnings means you have crossed into a higher tax band.

Assuming a standard personal allowance of £12,570, the income tax bands in this tax year for England, Wales and Northern Ireland are:

If someone’s income was £51,270, then they would pay 40% tax on the amount of income that falls within the higher rate band – that is £1,000. If they paid a pension contribution of £800 net, then basic rate tax relief of 20% (£200) would be added to give a gross pension contribution of £1,000.

When HMRC is working out how much tax that person pays they base it on their ‘adjusted net income’ which means deducting their gross personal contribution of £1,000 from their salary to give a figure of £50,270 and potentially avoiding higher rate tax.

THE LIMITS TO WATCH OUT FOR

One last thing to watch out. There are two main limits governing how much you can contribute to a pension and get tax relief.

Very briefly, an individual can contribute up to £3,600 or 100% of their UK relevant earnings, whichever is the higher (this is the gross amount including the tax relief). UK relevant earnings are generally earned income or self-employed income and doesn’t include any pension income or investment income.

The second limit is the annual allowance which covers your contributions, your employer’s contributions and any tax relief. That is usually set at £60,000 but could be lower if you have very high earnings or have ‘flexibly accessed’ your pension. 

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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