‘Should I pay my final salary pension into a Sipp to drop a tax band?'
So, although one part of the rules relaxing means you might be able to start paying in again, the tax relief rules might still get in the way of you achieving your goal of minimising your higher-rate tax, or mitigating it completely.
Tax relief and earnings
You can claim tax relief on the greater of 100pc of your UK earnings, or £3,600 in any tax year.
For most personal pensions, including Sipps, contributions are typically taken from pay after tax and topped up by basic-rate (20pc) tax relief returned from the Government, which is paid directly into the pension.
If an individual paid in £4,000, this would be topped up by £1,000 basic-rate relief, meaning £5,000 goes into their Sipp.
A UK resident with no earnings can pay in up to £2,880 a year, which is topped up by pension tax relief to £3,600.
You've mentioned that you receive income from a final salary pension scheme. Although pension income is taxed under income tax in the same way as salary or bonuses earned in your working life, it is not classed as earnings when calculating how much you can pay into a pension for tax relief.
The same goes for investment income like dividends, savings income or property rental income, even if you are paying higher rates of tax on these sources.
I'm afraid that unless you have earnings from another source, your ability to make pension contributions for tax relief is going to be very limited, meaning your strategy is unlikely to work.
The full list of what counts as relevant UK earnings can be found in the Government's pension tax manual.
Your question does raise some important points about how pension tax relief works, and the interaction with the personal savings allowance, so I've taken the chance to explain this below and it should help if you do have some earnings after all.
The second lever the Government uses to limit the value of tax relief is the annual allowance. This allowance is £60,000 per tax year for most people, and applies to the total gross pension contributions made by or for you across all your pension schemes.
So your own payments, the automatic government top-up and any employer contributions.
The allowance is lower for people with very high incomes (usually £200,000 plus), or those who have already accessed a pension using a flexible income option, like pension drawdown.
How pension tax relief works
I've mentioned that schemes like Sipps automatically top up money you pay in personally by 20pc tax relief. So, for every £800 you save, £1,000 in total ends up in the pension pot.
But people who pay more than 20pc tax on their earnings can claim more relief by contacting HMRC directly. This includes Scottish taxpayers paying intermediate tax (21pc) and above, and higher-rate (40pc) and additional-rate (45pc) taxpayers in the rest of the UK.
The amount of extra tax relief on offer will depend on someone's earnings, and how much falls into those higher rates of tax.
As you've pointed out, making a pension contribution and claiming that extra tax relief has the effect of expanding the basic-rate band, bringing all or some earnings out of higher rates of tax.
For people earning between £100,000 and £125,140, the tax-free personal allowance is gradually removed, resulting in an effective tax rate of 60pc – or up to 67.5pc in Scotland.
It's possible to use pension contributions to reduce taxable income, claw back personal allowance and boost retirement savings, if someone's UK earnings allow.
Personal savings allowance
You also mentioned the personal savings allowance. If someone can move out of a higher tax band thanks to pension contributions, it can help them get more of their savings interest tax-free.
This is because the amount of personal savings allowance someone has depends on your tax rate. Basic-rate taxpayers get a £1,000 allowance, but the allowance is halved to £500 for higher-rate taxpayers and lost completely for those paying additional-rate income tax.
How to claim extra tax relief
The Government has recently introduced an online service to help claim extra tax relief, which makes things much easier for those who don't usually have to complete a tax return and avoids getting stuck on the telephone to the taxman.
People who already complete a tax return will need to include their total gross (personal) pension contributions on the pension pages of their return to claim relief.
Most of the above on pension contributions also applies to charity donations made under gift aid, except that pension income received does count as income on which gift aid can be claimed. So, if you don't have UK earnings and still want to reduce your marginal rate of tax, you could consider your favourite charity.
I hope this has helped to answer your question, even though it might not be the tax outcome you were hoping for.
With best wishes,
– Charlene
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