Tax Relief On Pension Contributions

Simon Misiewicz

Simon Misiewicz

Expat & Property Tax Specialist

29th January 2016

Pensions can be confusing

I know from talking to clients that they are not investing in pensions. There are a number of reasons why this is the case. Here is a brief list of some of the common ones I hear:

– They can’t get access to the money now and have to wait until they retire

– Pensions themselves can be quite difficult to understand

– Pension growth is seen to be small compared to other investments

– The costs of running a pension are high

Can you relate to the above?

Invest or review your existing pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSAS pensions. Either way, we can help. Complete our online form, and we will get back to you with options.

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Are the above reasons why you are not investing in pensions right now?

If you have answered yes to these questions then you might be surprised to learn you could be missing out.

There are many advantages to pensions. These include:

– Tax relief on pension contributions

– The fact that income generated from the pension is tax-free

– The capital growth of the pension will always be tax-free until you withdraw the investment

– Pensions may be controlled by you to invest in commercial property. We have also written a more detailed article all about investing in commercial properties. Be sure to take a read.

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What is a pension anyway?

A pension, in short, is a pension scheme or arrangement whereby it provides benefits in one or more of the below circumstances:

– retirement

– death

– having reached a particular age

– serious ill-health or incapacity, or

– similar circumstances.

Invest in SSAS or a SIPP pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSIP or SSAS pensions. Either way, we can help. Complete our online form and we will get back to you with options.

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Types of pension benefits

The pensions tax legislation categorises the type of benefits a pension scheme will provide into the following four types of pension benefits:

Defined benefit – these schemes should provide a set amount of benefit, where the amount of benefit does not depend on how much money is within the scheme. Final salary and career average schemes are examples of defined benefit schemes.

Money purchase – also known as defined contribution. The amount of pension is not known in advance. It will depend on how much money is in the scheme. The size of the member’s pension pot in the scheme will depend on the contributions made.

Cash balance – these are a type of money purchase scheme. For the purposes of providing member benefits, the rules are the same as for money purchase/defined contribution benefits. The difference between pure money purchase and the cash balance is that the size of the member’s pension pot isn’t only dependent on the contributions that have been paid to the scheme.

Hybrid – these schemes may provide either defined benefit, money purchase or cash balance benefits. Only when benefits are drawn will the form of the benefit be set.

Invest or review your existing pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSAS pensions. Either way, we can help. Complete our online form, and we will get back to you with options.

Online form

Types of pensions — employee contributions

An employer pension scheme is often referred to as an occupational pension scheme. It may provide benefits as outlined above for its employees under Section 150(5) of the Finance Act 2004. And Section 30 of the Finance (No 3) Act 2010.

Employees can obtain tax relief on contributions they make from their own earnings into their pension up to a maximum of:

– £3,600 (for those not paying income tax); or

– the entirety of the member’s relevant UK earnings (up to the annual allowance)

While those making pension contributions will benefit from tax relief on their contributions, this is limited to £40,000 per year (pension contributions annual allowances) and there is a lifetime contributions allowance of £1,250,000 (tax year 2014-15).

You can go back two tax years and make pension contributions to utilise your annual allowance. Therefore you could, in effect, make £120,000 of pensions contributions in two years’ time.

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A note on salary sacrifice 

If you make pension contributions and are not part of a “salary sacrifice scheme” then you may only receive basic tax relief from the pension scheme. As such you will need to reclaim the additional tax if you are a higher rate or additional rate taxpayer on your self-assessment. You’ll get a statement from your pension provider.  This statement tells you how much tax you owe if you go above your lifetime allowance. Your pension provider will deduct the tax before you start getting your pension.

Types of pensions — employer contributions

Did you know that your employer (also your own business) can pay into a pension on your behalf? Not only can you personally pay into a pension and benefit from a tax relief but your company can to. As an added bonus the pensions contribution that the company makes is also tax allowable.

A new law means that every employer must automatically enrol workers into a workplace pension scheme if they:

– are aged between 22 and State Pension age

– earn more than £10,000 a year

– work in the UK

This is called ‘automatic enrolment’.

Usually, your employer takes the pension contributions from your pay before deducting tax (but not National Insurance contributions). You only pay tax on what’s left. So whether you pay tax at the basic, higher or additional rate you get the full relief straightaway.

If your employer can’t deduct your pension contributions from your pay you can still get tax relief. You’ll need to claim the tax relief you’re due through your tax return, or if you don’t complete a tax return by contacting HM Revenue & Customs (HMRC).

However, some employers use the same method of paying pension contributions that personal pension scheme payers use – read more in the section on ‘Personal pensions’

Many employers have either a company pension scheme that they’ve set up for their employees or provide access to a group personal scheme. Your employer will also contribute towards your pension.
From October 2012 employers had to start enrolling their employees into a pension scheme and pay contributions for them.

Employers may make pension contributions for their employees. There is no limit to the amount of money that the employer may contribute on behalf of an employee. However, care must be taken not to exceed the employee’s annual pension contributions limit. Any excess may be taxable by the employee and have a surprise of nasty tax liability. The annual pension contributions for an employee is currently £40,000.

The employer benefit of making pension contributions over salary payments is the employer’s national insurance savings. In some cases, the employer’s can save 13.8% National Insurance.

Invest in SSAS or a SIPP pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSIP or SSAS pensions. Either way, we can help. Complete our online form and we will get back to you with options.

Online form

Corporation tax treatment of defined benefit pensions contributions 

Employers may reduce their corporation tax liability by the amount of money that they have invested in the pension as it is deemed that employer contributions are an allowable cost.

Sections 307 and 308 of the Income Tax (Earnings and Pensions) Act 2003

The contributions an employer makes to a registered pension scheme on behalf of an employee are exempt from being taxed as earnings for the employee. However, the employer’s contributions will count towards the member’s annual allowance limit. So the member may have to pay tax if the employer contributes too much.

Where the employer is a company with investment business the employer contributions will be deductible as an expense of management (Chapter 2 of Part 16 of the Corporation Tax Act 2009).

Payments made on behalf of directors and shareholders of the company 

Payments made on behalf of the directors/shareholders are considered to be wholly and exclusively for the purposes of the trade. As such these contributions will benefit from corporation tax relief.

If you are part of an employer scheme and you personally make pension contributions, you are entering into a salary sacrifice arrangement whereby you get tax relief at source on pension contributions in each and every pay packet, be it weekly or monthly.

Invest or review your existing pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSAS pensions. Either way, we can help. Complete our online form, and we will get back to you with options.

Online form

Are all the employer's contributions towards a personal pension allowable

Payments made to employee’s pensions

As shown in the S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009 that pension contributions are allowable. This is provided that the employer pension contributions is to an employee or director of the company. Any payments made to the employee’s pension contribution will be seen as Wholly Exclusive and Necessary. HMRC will look at the case where pension contributions seem excessive to the salary provided to the employee. HMRC may take a dim view where the employee is paid £10,000 as salary but £40,000.

Any payments made from the employer to the employee’s pension contributions in a winding-up situation will not be allowed. As HMRC’s website shows. There was a court case CIR v Anglo Brewing Co Ltd [1925] 12 TC 803 that has significance. In this court case, it was shown that payments to a going concern are allowed but not one that is in a winding up situation.

An employer cannot make excessive employer contributions to the market value the person would receive for the same job elsewhere.

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Want to save tax in the future?

We have now created free online tac courses to help you build wealth whilst paying less tax. Learn today and save tax tomorrow. We have covered the basics of tax filing with HMRC and IRS. We have created courses on advanced planning strategies that will save you tax in the future.

We have training programmes for UK tax and US tax. Learn today and save tax tomorrow

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Excessive payments made to an employer contributions example

Mrs B’s experience and qualifications could help her earn £40,000. The employer would not be allowed to make excessive contributions towards the pension. If she was paid a salary was £30,000 and made £40,000 employer pension contributions were made; the total amount would be £70,000 and this could be seen as excessive in the eyes of HMRC. Sadly there is no guidance from HMRC to say what is excessive.

However, if the employee agrees to a salary sacrifice then the employer pension contributions will be allowable. For example, the employer pension contributions will be allowable if Mrs B was paid a salary of £40,000 but chose to make a salary sacrifice. Mrs B wishes to reduce her salary by £30,000, which would then be paid to her pension.  She would be paid a £10,000 salary and a £30,000 pension contribution. These costs would be allowed.

Invest in SSAS or a SIPP pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSIP or SSAS pensions. Either way, we can help. Complete our online form and we will get back to you with options.

Online form

Employer pension contributions made to directors and shareholders

The relevant piece of legislation on this point is the S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009. Any payments made to the directors and shareholders of a company are allowable provided it meets the Wholly Exclusive and Necessary tests. HMRC’s website shows that employer pension contributions will not be allowed if the person in question is not involved in the business. Examples are relatives of the directors or shareholders.

Pension contributions limited to £10,000

Whilst the above was a very nice way to invest and get tax relief, the government have decided to stop people benefitting from the tax relief by investing in their future, as can be seen from their website.

The amount of money that you can invest in a pension now drops from £40,000 for every £2 you earn over £150,000. If you earn £160,000, then this is £10,000 over the £150,000 rate.

This means that the pension contribution allowance is reduced by £5,000.

This person could now contribute £35,000 into their pension and get tax relief on it.

If you earn more than £210,000, then the maximum amount of money that you can invest in a pension is limited to £10,000. Our specialist tax advisers can assist you further in discussing your wealth planning.

Invest or review your existing pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSAS pensions. Either way, we can help. Complete our online form, and we will get back to you with options.

Online form

Practical steps you should now take to make the most of your pension

– Set up a registered pension (scheme administrator) through an agent or IFA, making sure they have permission from the Financial Conduct Authority (FCA)

– HMRC will then consider the pension registration and inform the employer/scheme administrator of their decision on whether to allow registration or not

– HMRC will provide a registration date of the pension

If you want to know more then please read our “buy to let tax tips for UK landlords” article

Saving your Child Benefits by contributing towards a pension

If you are an employee and you have offspring then you may be aware that you can claim child benefit from the government. The amount that you can claim is:

– £21.15 per week for the first child

– £14.00 per week for each child thereafter

You normally qualify for Child Benefit if you’re responsible for a child under 16 (or under 20 if they stay in approved education or training) and you live in the UK.

If you have not done so already you can make a claim by using this link.

You may also be aware that child benefits are reduced if you or your spouse earn more than £50,000. Any excess of the £50,000 will be charged against the child benefit that you have received. This tax charge will be taken via your self-assessment as part of the work we do for our clients.

Earned salary less £50,000:

———————————     (% result) X Child Benefit Received

100

Someone earning £55,000 would therefore have a tax charge of:

50% = £5,000 (£55,000 less £50,000) divided by 100

£549.90 = 50% (above) £1,099.98 (52 weeks X £21.15).

If the employee in question had invested £3,000 into the pensions he and the employer would have received the following savings:

– £60 – 2% employee national insurance contributions at the high rate tax band

– £1,200 – 40% income tax relief

– £538.20 child benefit tax charge avoidance as they now earn the limit of £50,000

– £1,798.20 total savings

If we also considered the employer’s savings we would see total benefits of:

– £1,798.20 Employee savings: income tax, national insurance and child benefit tax charge avoided

– £414 employers national insurance savings (13.8% X £3,000)

– £2,212.20 total savings enjoyed by the employer and employee

The savings of £2,122.20 is now 73.7% of the £3,000 originally invested.

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Want to save tax in the future?

We have now created free online tac courses to help you build wealth whilst paying less tax. Learn today and save tax tomorrow. We have covered the basics of tax filing with HMRC and IRS. We have created courses on advanced planning strategies that will save you tax in the future.

We have training programmes for UK tax and US tax. Learn today and save tax tomorrow

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Pitfalls of pension contributions 

It is possible that an employer may have made £40,000 pension contributions on the behalf of the employee. However, without both the employee or employer knowing that the level of contributions has exceeded the annual allowances. In this case, we will assume that the employee is a high rate taxpayer. The £10,000 excess will then have a £4,000 (40%) tax charge.

It can get much worse, without the right tax advice and wealth planning professional inputs. Let’s assume that an employee draws down some of his pension to get 25% tax relief and starts to take the pension benefits annually. This would reduce their pension contribution annual allowances from £40,000 to £10,000 based on the governments’ website known as Money Purchase Annual Allowance (MPAA).

If we now look back and see that the £40,000 pension contributions exceed the £10,000 by £30,000. As such, the employee will then have to pay a tax of £12,000 (£30,000 x 40%).

You need to be mindful of:

– What your annual allowances are for pension contributions

– Who make the contributions

– Who gets the tax relief

If you are a business owner, it provides additional benefits:

– Gets money out of the limited company in a tax-efficient way

– The above reduces the overall value of the business from an inheritance tax perspective

– You do not need to increase your salary costs to make the pension contributions, which would incur national insurance costs for both the employee and employer

Invest in SSAS or a SIPP pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSIP or SSAS pensions. Either way, we can help. Complete our online form and we will get back to you with options.

Online form

What is an SSAS pension?

Wikipedia gives a relatively straightforward explanation of what a Small Self Administered Scheme (SSAS) is. It is a type of UK Occupational Pension Scheme.

Schemes are trust-based and established individually, usually by directors of limited companies for specified employees of the company. Since Pension Simplification (also known as A-Day), SSAS has been available for the establishment by those who are not in a limited company (i.e. Partnerships and Families).

SSAS registered with HMRC may enjoy tax-exempt status, all investments made will be free of Capital Gains Tax, and contributions to the SSAS will receive tax relief (if contributions are made by a “Relevant UK Individual”).

Basic rate tax relief can be claimed by the SSAS itself, and any higher rate tax would be claimed through the member’s tax return. However, it should be noted that the vast majority of SSAS does not reclaim tax on members contributions as this would require the scheme Trustee / Administrator to apply for Relief at Source via HMRC.

Provided that the members of the SSAS pension scheme are also trustees, there is a lesser regulatory requirement than if all members were not trustees. This is because the members of the SSAS pension scheme are deemed to be investing the funds for themselves.

The trustees can invest the funds as they consider appropriate to the needs of the SSAS pension scheme. For example, the trustees can invest the assets of the pension scheme in the company that sponsors the SSAS pension scheme – a process known as pension-led funding.

This can take the form of loans to the employer and the purchase of shares in the sponsor, however, there are limits that apply. One must be very careful purchasing shares in the company through an SSAS, ‘Taxable moveable property’ laws can easily be breached. Guidance from the SSAS Practitioner or Administrator is required.

Invest or review your existing pension

You may already have a pension, which you wish to review. You may be looking to create or invest more into a SSAS pensions. Either way, we can help. Complete our online form, and we will get back to you with options.

Online form

SSAS pensions and residential property investments

HMRC and Section 174A and Paragraph 6 Schedule 29A Finance Act 2004 shows that if an investment-regulated pension scheme directly or indirectly acquires taxable property (residential property or tangible moveable property) this will create an unauthorised payment charge on the member whose arrangement acquires the asset. In addition, the scheme administrator will be liable to a scheme sanction charge on both on income from the taxable assets and capital gains at their disposal.

Direct Residential Property Investments - Tax Charges

HMRC shows that if an investment-regulated pension scheme acquires a direct holding in taxable property this creates an unauthorised payment on the member for the purposes of whose arrangement the property is held. So the member is subject to the unauthorised member payments charged at 40% on the relevant unauthorised payment value. The scheme administrator is liable to the scheme sanction charge, generally an amount of 15% of the value. If certain limits are exceeded the member may also be subject to the unauthorised payments surcharge at 15%. See PTM134000 for further details of all these charges.

Income or deemed income received in relation to the asset is charged to the scheme sanction charge so the scheme administrator is liable to the scheme sanction charge at 40%. See PTM135000 for further details of this charge.

Free Online Tax Courses

Want to save tax in the future?

We have now created free online tac courses to help you build wealth whilst paying less tax. Learn today and save tax tomorrow. We have covered the basics of tax filing with HMRC and IRS. We have created courses on advanced planning strategies that will save you tax in the future.

We have training programmes for UK tax and US tax. Learn today and save tax tomorrow

Free online tax course

Free – Access NOW!!

Indirect Residential Property Investments - Tax Charges

As shown in Section 174A and Paragraphs 16 to 19 Schedule 29A Finance Act 2004 the taxable property provisions apply where an investment-regulated pension scheme holds either a direct or indirect interest in taxable property. PTM121000 explains the position for direct interests and the following paragraphs explain the position for indirect interests.

An indirect interest in the taxable property will be held through a “vehicle”, i.e., a person or entity through whom the pension scheme holds the property. So if a pension scheme holds 100% of the share capital of a company that itself owns residential property then the company through which the pension scheme owns the property is the vehicle.

Indirect investment in taxable property via genuinely diverse commercial vehicles will not be subject to the tax charges on taxable property.

A person indirectly holds an interest in a vehicle if the person:

– holds an interest in a person who holds an interest in the vehicle, or

– holds an interest in a person who holds the interest in another person who holds the interest in the vehicle and so on down through any length of chain of interests held.

A pension scheme holds 100% of the shares in company A and company A holds 50% of the shares in company B. The pension scheme indirectly holds an interest in company B of 50% (i.e. 100% x 50%).

An indirect interest in a taxable property can be held via a wide variety of types and sizes of vehicles or structures including collective investment schemes, unit trust schemes, unauthorised unit trusts, exempt unauthorised unit trusts, open-ended investment companies, closed-ended companies, investment trust companies, insurance policies and contracts, trusts, depository interests, or exchange-traded funds.

Only limited indirect investment in taxable property will not be subject to the tax charges on unauthorised payments. This is through genuinely diverse commercial vehicles.

Indirect investments held through genuinely diverse commercial vehicles will not be subject to tax charges when held as a scheme investment by an investment-regulated pension scheme. There are three categories of genuinely diverse commercial vehicles:

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