How to Calculate and Claim Higher Rate Tax Relief

As pensions now have greater flexibility and are attractive from a tax perspective, larger pension contributions are commonplace for higher rate or additional rate taxpayers. In this article, we will focus on how higher rate tax relief is calculated and how it is claimed. This should be of interest to anyone studying towards the R04 or other CII pension-related exams.

THIS ARTICLE IS RELEVANT TO EXAMINABLE TAX YEAR 2021/22.

Let’s look at an example to show how higher rate tax relief is calculated. Say a client earns £60,000 pa and wishes to make a gross single pension contribution of £20,000 in the 2021/22-tax year. The first thing to note is that the full £20,000 will not obtain higher rate tax relief at 40%.

Calculating the tax relief

First, we need to calculate how much of the client’s income is in the higher rate band. I’m sure many of you can do this quickly, however, let’s break down the full steps for those who need to build their understanding of this process.

Starting income is £60,000.

Deduct the personal allowance of £12,570.

Deduct the basic rate tax band of £37,700.

So, the income subject to higher rate tax = £9,730.

The next stage is to calculate what the pension tax relief will be.

Let’s assume the client’s pension scheme uses the relief at source method.  The client will automatically receive basic rate tax relief on the £20,000 gross contribution (£4,000), and so the client only pays £16,000 into the pension, with HMRC providing the rest.

As only £9,730 is subject to higher rate tax, this is the limit of the gross contribution that will receive higher rate tax relief.

So, £9,730 of the gross contribution would receive an additional 20% tax relief (or a further £1,946).

The total tax relief is therefore £5,946 (or effectively 29.73%).

The client will need to claim this additional tax relief via a self-assessment tax return or by an adjustment to their tax code. If using the self-assessment route, HMRC will increase the basic rate tax band by the amount of the gross pension contribution.

Factors to Consider and Double-Check

• Has the client got an employer scheme, either via salary sacrifice or member contribution? Remember to take this into account.
• Is the client also making regular contributions? Don’t forget to take these contributions from the amount that higher rate tax relief can be granted on.
• Do you limit the contribution to the amount that will receive the full higher rate tax relief? If you know the client only has a one-off sum and is unlikely to max out their contributions in the following year, you could split the contribution over two tax years to ensure all of the contribution receives 40% tax relief. The likely future funding level is also an important factor to consider.

Finally, many people simply forget to claim for their higher rate tax relief (or don’t realise they need to do so).

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