How to claim pension tax relief (while it lasts)
This week s great news for pension savers a reduction in tax due on pension money passed on at death could carry a sting in the tail. There are fears that the newly announced tax cut for people who bequeath their pension to the next generation will be offset by a reduction in the tax breaks that apply when you save the money in the first place.
In other words, the huge improvements to savers choices and tax situation when they take money out of their pension could be counteracted by a future cut to the tax perks when savers put money in.
Chancellor George Osborne announced on Monday at the Conservative conference that from next April any money left in the pension pot of someone who dies before the age of 75 could be inherited completely tax-free. For deaths at 75 or over, the bequeathed money can remain in a pension with no tax to pay or be withdrawn by the recipient, subject to his or her normal rate of income tax.
Under the current system, which will be scrapped in April, there is a penal 55pc tax charge on inherited pensions; the only exception is when the pension saver never withdraws any money from the plan and dies before the age of 75 when there is no tax to pay.
In effect a tax of 55pc will be replaced by one of either zero or between 20pc and 45pc, depending on the recipient s income and when the money is withdrawn.
Unlike with ordinary inheritance tax, the 55pc on an inherited pension applies to the entire sum there is no £325,000 tax-free nil-rate band.
The change, combined with the new freedom, announced in the Budget, to allow pension savers unrestricted access to their money after the age of 55, will make pensions a far more attractive means of saving for many. The freedom to do as they wish with the money during their own lifetimes will be extended to future generations in fact some commentators say we can expect to see everlasting pensions that pay an income to successive generations with the capital left intact.
There is much more detail on these changes, in the form of a comprehensive Q A .
and the potential bad news
These substantial new attractions of pension saving could be undermined if the Government curtails the current very generous tax breaks on the money that is put into pensions contributions are made from untaxed income. There are fears that full tax relief for higher-rate (40pc) and top-rate (45pc) taxpayers will be scrapped and replaced by a flat rate 30pc relief for savers of all incomes.
Politicians from across the spectrum have stated, or hinted, that savings could be made by cutting back the tax relief paid on higher earners pension contributions.
Malcolm McLean of Barnett Waddingham, the pensions consultancy, said: The days of higher-rate tax relief are almost certainly over. Laith Khalaf of Hargreaves Lansdown, the investment shop, said: The ground has been prepared for a cut to tax relief with Mr Osborne s latest pension policy.
Removing higher-rate tax relief now looks like a no-brainer for the Conservatives and I d expect to hear more in the Autumn Statement in December or in the election manifesto.
If these experts are right, the only way for savers to get the best of both worlds the top rate of tax relief on contributions and unrestricted withdrawals without penal rates of tax is to pay money in quickly between now and the Autumn Statement in December.
However, the practicalities of higher-rate tax relief on pensions are complex. If you want to benefit from it now, before its possible abolition in a few months time, here is our step-by-step guide to the process.
Our guide to achieving the best of both worlds
If you re in a works pension scheme, you probably don t need to do anything. It s all done for you. That s because the money you pay into your pension pot and it doesn t matter whether your pension is a final salary sort or not gets paid in before tax. In effect, you get the benefit of tax relief at your highest rate of tax automatically. So if you pay 40pc tax, or 45pc, that s the benefit you get on your contributions. You don t need to claim any further relief.
But if you have a personal pension, or a self-invested personal pension (Sipp), or a stakeholder pension, it s less easy. Here s how it works.
1. You make a payment into your pension pot
Just as if you were paying into an Isa, you move money from your bank account into your Sipp. For ease of calculation, say you pay in £800.
2. Your pension firm boosts your contribution by the 20pc basic rate tax relief
Most big providers add the basic rate of tax relief instantly, so in this case your pension pot gets £1,000 (in other words, your contribution is boosted by 25pc).
3. Your pension provider then goes to HMRC and claims that money back
This is how it works with most big providers. But John Lawson, pension expert at insurer Aviva says: It can take the pension scheme an average of six weeks to get that tax relief from HMRC, and some smaller Sipp providers don t add the 20pc tax relief to your pension until they receive it from HMRC.
Remember, there are limits to how much you can contribute to a pension each year, linked to your earnings. Everyone including children can put in £2,880 without earning anything at all. If you don t have enough net relevant earnings to cover your contribution, it s likely to be picked up at this stage.
4. Now you claim the extra 20pc tax relief (for 40pc taxpayers)
The easiest way to claim the extra is via your self-assessment tax return. There is a box on the form where you can declare the gross pension contribution (ie, in the above example, £1,000). But when would you do it? If you are now getting down to filling in your tax return for the year ending April 2014 (which you can send in at any time between then and the deadline on January 31, 2015) you will be including any contributions made during that period. Equally, if you make a payment into a pension now (October 2014), it would appear in the return you file for the next year.
5. So when do you get the money?
The most common way of receiving the benefit is in the form of lower tax bills, based on an adjusted tax code for the rest of the tax year. So if you made a contribution now, included in your return filed by January 31, 2016, that could be reflected in the tax code applied to your earnings for the rest of that year and possibly the next depending on how much of a rebate was due.
John Lawson adds: If you write to HMRC or call them, you could get your tax relief sooner. For example, if you paid a contribution on October 1 2014 and telephoned or wrote to HMRC immediately, your tax code would be adjusted upwards for the remainder of the 2014/15 tax year.
6. But how does that extra relief end up in my pension?
It doesn t. There is a common misconception that higher rate tax relief goes straight into your pension pot. But it doesn’t. You need to pay it in, effectively starting the whole process again. And for those paying the maximum amount in per year currently £32,000 plus the £8,000 basic relief, you would need to be a high earner with plenty of spare cash you would have to wait until a new tax year to add the extra £8,000.
As a result, most people who want the benefit of their higher-rate tax relief to go into their pension simply increase their original contributions. Laith Khalaf explains: Basically, if you want more in there, you contribute more to begin with. Savers into Sipps and personal pensions need to recognise that the way the system works means the higher-rate relief isn t actually going into the accounts.
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