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Suppose you are a higerh rate Tax earner, and you pay into a monthly pension. As per these questions:

and also my company's Finance Department, the standard description of how the tax works is this:

  • You pay £80 into your pension, after (40%) Tax.
  • Your pension provider claims £20 of basic rate (20%) tax ("relief at source", I believe)
  • You tell HMRC about it, and get another £20 back from HMRC (for the other 20%).

This description is so consistently given, that I believe it must be right. But I don't understand why ....

I assume that the premise is:

"The government decided that pensions are a GoodThing(TM), so if you're going to put your income into a pension then it doesn't get taxed."

I feel like the following logic ought to be valid:

  • Supposing I'm receiving an extra £1,000 of gross salary, and I want to put it into a pension, then I should be able to put all of that into a pension. Thus my pension ought to go up by £1,000.
  • But in reality, I don't receive £1,000 ... I receive £600, because 40% tax.
  • Then I give that £600 to the pension provider.
  • Based on the model in the above questions, the pension provider would claims back £150. (£20 / £80 = 0.25 | 0.25 * £600 = £150)
  • Again based on the model in the above questions, I contact HMRC and get given another £150.
  • Now I have £750 in my pension, and £150 in hand. Total: £900

What happened to the other £100?

What is it that I've misunderstood.

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You've misunderstood the amount you need to pay into your pension. You receive £600 in net salary, but you pay in £800 initially. Then they claim £200 to get the £1000, and you claim £200 from HMRC so your net payment is £600. Your calculation has you making a gross payment of £750, not £1000, so the other £100 went in 40% tax on the £250 gross pay you didn't pay into your pension.

The easiest way to work out the right payment is to remember that the system is set up so your pension provider can act as if everyone is a basic rate taxpaper (though the situation is a bit more complicated for non taxpayers). £800 is what you would have got from a gross salary of £1000 if you were a basic rate taxpayer, so £800 is what you pay them to get a gross contribution of £1000.

HMRC will actually adjust your tax code for the next tax year based on the pension contributions it knows about (the exact timings depend on when it finds out about them), so if you make similar contributions each year you'll find the £200 payment from HMRC arrives automatically due to less tax being withheld from your pay each month.

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    Ah! I see ... Using the original model from other answers the claim to HMRC isn't "I've only got £100 in my pension - I should have £120". It's "I've got £100 in my pension, but I should only have had to put £60 in to achieve that ... instead I put in £80, so please can I have £20 back?". Is that right? – Brondahl Aug 25 at 13:47
  • @Brondahl Yes: HMRC always pay the same amount to your pension provider, and you claim any extra back to your own pocket. (The way they work it out on your tax calculation is a bit confusing, as they mess around with the size of the tax band rather than putting it in directly in terms of a refund, but the effect is the same. Their way probably makes sense to make sure they do the right thing if a pension payment means you cross a boundary.) – Ganesh Sittampalam Aug 25 at 13:51

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