Tax Relief
To reward you for saving money for your retirement, the government pays tax relief on your savings. Essentially, the government pays you money for saving. There are limits on the amount of tax relief you are entitled to however, that is, a limit to the amount of money you can receive from the government for actively saving. The amount of tax relief that the government offers depends on the current tax rate. The basic tax rate is currently twenty-two percent, therefore tax relief is also currently set at twenty-two percent. This tax relief means that the government pay you £22 of every hundred pounds you save for your pension, thus to save £100 of pension you must contribute £78 and the government will pay the remaining £22. This tax relief is usually added automatically to your pay check or pension scheme, and so you do not need to personally chase it up. If you are entitled to extra contributions to your pension scheme from your scheme provider, these will not be affected by tax relief: you will receive tax relief as well as these extra contributions.
Tax relief is not calculated as a simple percentage, that is, the fact that tax relief is currently set at twenty-two percent does not mean that if you contribute £100 to your pension savings scheme you receive £22 in tax relief. Tax relief is calculated as £22 for each £78 you contribute. In essence, this means that any contribution you make to your pension savings scheme is seen as a net contribution, that is, one which has already been taxed. Therefore your pensions saving scheme will, essentially, ‘claim back’ the tax you paid on your contribution. The basic tax rate is currently set at twenty-two percent. Thus, every contribution you make is seen to be seventy-eight percent of what you wished to contribute, and the pension savings scheme claims back the missing twenty-two percent ‘tax’ to make up the gross contribution. Of course, you never paid tax on your contribution but this extra twenty-two percent, the tax relief, is there to encourage you to save for your retirement by enabling you to save up more money than you contributed.
If you contribute £100 to your pension savings scheme, you will receive £28.20 of tax relief, bringing your total ‘gross’ contribution to £128.20, plus any bonus contributions that you are entitled to from your pension scheme provider. How the tax relief is calculated is explained below:
- tax relief is £22 for every £78 you contribute
- how many lots of £78 are in £100?
- £100 divided by 78 = 1.2820 lots of £78 in £100
- if there are 1.2820 lots of £78 in £100 then you are entitled to this number of lots of £22 (entitled tax relief)
- 1.2820 multiplied by £22 = £28.20 (total tax relief on £100)
- £100 contribution + £28.20 tax relief = £128.20 ‘gross’ contribution
essentially this calculation is:
gross contribution = net contribution + ( (net contribution / 78) x 22)
