CAT / FIA FTX Syllabus C. Income Tax Liabilities - Pensions - Notes 1 / 2
Types of pension schemes
Occupational pension schemes
These are pension schemes that are run by an employer.
An employee can contribute into the scheme and an employer can contribute into the scheme on behalf of the employee.
If an employee contributes into the scheme, tax relief is given as follows:
The contribution made by the employee is deducted from their salary in arriving at taxable income.
It is basically treated as an allowable expense.
Illustration 1:
David has a salary of £20,000 for the year ended 05/04/2024.
During the year he has contributed £1,000 into his occupational pension scheme.
What is his taxable income for 23/24?
Solution:
| Salary | £20,000 |
| Less: | |
| Pension contribution | (£1,000) |
| Net income | £19,000 |
| Less: | |
| Personal allowance | (£12,570) |
| Taxable income | £6,430 |
Registered personal pension schemes
Any individual (whether employed or not) can join a Personal pensions scheme.
It is run by banks, insurance companies or other financial institutions.
Stakeholder pensions are a type of personal pension scheme.
They must satisfy certain rules, such as maximum level of charges and ease of transfer.
3 tax benefits:
There are 3 tax benefits available for making personal pension contributions into a registered scheme.
They are exactly the same as the tax benefits available for making gift aid donations.
These are:
Pay net of 20%.
For example, if an individual want to make a personal pension contribution of £1,000, he needs to pay 80% and HMRC will make the remaining 20% contribution on his behalf.
Therefore, he will pay £800 and HMRC will pay £200 to the fund.
Increase the basic and higher rate bands by the gross personal pension contribution.
Therefore, this same individual will increase his basic rate band to £38,700 and his higher rate band to £126,140.
This will result in an additional £1,000 being taxed at the lower rate of 20%, and an additional £1,000 being taxed at the higher rate of 40%.
Gross personal pension contributions are deducted from net income to arrive at adjusted net income.
Adjusted net income is used to determine the amount of personal allowance available. (Topic: Personal allowance)
Illustration 2:
Eli has a trading profit of £55,000 and he paid £2,400 (net) to a registered personal pension scheme in the tax year 23/24
Show the tax benefits of this contribution.
Calculate Eli’s income tax liability for 23/24.
Solution:
Benefit 1:
| Eli paid | £2,400 (80%) |
| HMRC paid | £600 (20%) |
Benefit 2:
| Basic band extension: | £37,700 + £3,000= | £40,700 |
| Higher band extension: | £125,140 + £3,000 = | £128,140 |
Benefit 3:
| Adjusted net income = | £55,000 - £3,000 | £52,000 |
| Income tax liability | |
| Total income | £55,000 |
| Personal allowance | (£12,570) |
| Taxable income | £42,430 |
| £40,700 * 20% = | £8,140 |
| (£42,430 - £40,700)* 40% = | £692 |
| Total income tax liability | £8,832 |
Limitations of the tax relief available
Pensions do have the taxable benefits mentioned above.
However, there are 2 limitations under which contributions must be to qualify for the tax relief outlined.
These are:
They must be within the relevant earnings of the individual. If not, a certain amount of the contribution will be taxable.
If they are within the relevant earnings, they must be also within the annual allowances of the individual. If they are not, a certain amount of the contribution will be taxable.
What are relevant earnings?
These are the greater of
£3,600 and
100% of:
Trading income (e.g) profits from a business
Employment income (e.g.) salary
Income from furnished holiday lettings (e.g.) rental income from a FHL
For example
if an individual has trading profits of £50,000, then the greater of £3,600 and £50,000 will be chosen as relevant earnings, £50,000 will be the relevant earnings.
if an individual has trading profits of £3,000, then the greater of £3,600 and £3,000 will be chosen as relevant earnings, £3,600 will be the relevant earnings.
What is the annual allowance?
This is an allowance given to individuals every year.
The individual can use the allowance yearly, and the amount unused is carried forward for 3 years.
Therefore, at any particular time, an individual can use their current year allowance plus 3 years’ b/f unused annual allowances on a FIFO basis.
The gross contributions are deducted from the annual allowances.
| 2020/21 | £40,000 |
| 2021/22 | £40,000 |
| 2022/23 | £40,000 |
| 2023/24 | £40,000 |
Illustration 3:
Sally's trading income for the year ended 05/04/2024 were £60,000.
Sally made contributions of £56,000 (gross) into a personal pension scheme during the tax year 23/24.
She has made gross pension contributions of £30,000 for the last 10 years.
How much of the pension contribution qualifies for relief?
What is the income tax liability of Sally?
Solution
Sally’s relevant earnings are the higher of £3,600 and £60,000:
Therefore, Relevant earnings is £60,000.
Therefore, the pension contribution is within 100% of relevant earnings.
However, is the contribution within the annual allowance?
| Current year annual allowance | £40,000 |
| 19/20 b/f annual allowance 40,000 - 30,000 | £10,000 |
| 20/21 b/f annual allowance 40,000 - 30,000 | £10,000 |
| 21/22 b/f annual allowance 40,000 - 30,000 | £10,000 |
| Total allowance | £70,000 |
| Gross contribution | £56,000 |
| Total allowance | (£70,000) |
| The contribution is within the annual allowance, therefore £56k qualifies for the tax relief |
| Income tax liability | |
|---|---|
| Trading income | £60,000 |
| Personal allowance | (£12,570) |
| Taxable income | £47,430 |
| Total income tax liability £47,430 x 20%* = | (£9,486) |
*
| Basic Band extension: £37,700 + £56,000 | £93,700 |
| Therefore we will multiply £47,430 by 20% |