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I can solve the question but I dont understand one thing. What “actual” benefit are basic rate people getting?
I mean person A has 20000 salary and makes a contribution of 10000 gross for pension. Person B has 20000 salary and makes no pension contributions.
Both of them will have exactly the same tax liability so where’s the benefit for person A??
Is person A going to get tax relief of 2000? If yes then why include it in calculating the tax liability? The BPP book didnt quite explain this well I think. :SBasic rate taxpayers don’t get any relief, the relief is only available to higher rate tax payers by extending the basic rate band.
We extend the basic rate band by adding the gross pension contribution to the basic rate band. For FA2009 it is £37,400 + (pension contribution x 100/80)
This in effect allows a tax benefit of 20% (40%-20%) for higher rate tax payers. If the basic rate band wasn’t extended for pension contributions then higher rate tax payers with income exceeding the basic rate band of £37,400 would be taxed on 40% of anything above that band.
*Same principal for gift aid donations
Hope that is clear enough for you
Here’s an example:
Salary £25,000
Building Society Interest £12,000
Dividend Interest Received £4,500
Gift Aid Donation £800 (net)Income tax computation
NSI
SI
DI
Total
Employment Income
£25,000
BSI (£12,000 x 100/80)
£15,000
DI (£4,500 x 100/90)—-
£5,000
NET INCOME
£25,000
£15,000—£5,000
£45,000—
less PA
(£6,475)
—
TAXABLE INCOME
£18,525—-£15,000—-£5,000
£38,525—Extending the basic rate band for gift aid donation:
£37,400 + (gift aid donation x 100/80)
£37,400 + (£800 x 100/80)
£37,400 + £1,000
£38,400NSI—£18,525 x 20% =
£3,705
SI—-£15,000 x 20% =
£3,000
DI
£4,875 x 10% =
£488
£125 x 32.5% =
£41
TAX LIABILITY
£7,234
less tax suffered at source BSI–(£3,000)
less tax credited for DI
(£500)
TAX PAYABLE
£3,734*Note: The extended rate of £38,400 is taxed at 20% instead of the usual basic rate of only £37,400 (if there was no relief the £1,000 would be taxed at 40%, therefore a tax save of 20%)
I have got it now that’s why deleted the last 2 posts as they would only cause confusion. I just want to know one more thing. A person earns 55000 but contributes 65000 gross to a pension, what happens here? The question I did seems to have ignored the excess 10000 altogether in calculating the tax liability. Is that right?
Gary had employment income of 55000 for 200910. He paid 65000(gross) into his personal pension scheme.
Calculate Gary’s income tax payable.
The answer given is 9705.
BPP F6 text book 2010 question no. 6(b) in the exam question bank.Gary – Income Tax Computation 2009/10
Employment Income £55,000
Less PA………………(£6,475)
Taxable Income……..£48,525Extend basic rate band for personal pension scheme
£37,400 + £55,000 = £92,400*Edit: Maximum contribution relieved is higher of:
1) Basic amount £3,600
2) Gary’s relevant UK earnings chargeable to income tax in the year*Tax payable
NSI – £48,525 x 20% = £9,705If the relief for personal pension contribution did not exist the tax payable would be as follows:
£37,400 x 20% = £7,480
£11,125 x 40% = £4,450
…………………..£11,930Therefore we have a tax save of £2,225 (£11,930 – £9,705)
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@acltang72, thanks for the good elaboration.if i may ask, how much relief can a person get from his/her contribution into the pension scheme?
I thought in the above case gary was to extend his basic rate band by only $55,000,as per his earnings. please assist.
thanksBut why are we ignoring the 10000 extra paid by gary? Why is that not taxed?
And I dont think you can extend the band by 65000 here, it should be 55000 although it wont matter as far as the final answer is concerned.
Hi,
May i just clarify that you can only get relief on pension contribution of either 3600 or 100% of income.
In the above question the extended basic rate band would be 37400+55000= 92400.
Pls note that it does matter to get this clear because if the taxable income was more than 92400, you would have gotten your final answer wrong if you extend the basic rate incorrectly.i hope it helps
@ herlima
@ gambler747
@ temi
Sorry you are right the basic rate band should be extended to £55,000, thanks for pointing it out!@ gambler747
Maximum contribution relieved is higher of:
1) The basic amount of £3,600
2) The individual’s relevant UK earnings chargeable to income tax in the year*That’s why the extra £10,000 isn’t relieved
If gary had made a pension of 55000 instead of 65000 then the answer remains the same. Why is that? Shouldnt we charge 10000 x 40%?? We are basically ignoring the excess paid over his income…
@ gambler747
Extend basic rate band for personal pension scheme
£37,400 + £55,000 = £92,400Gary would only be taxed at 40% on anything above the extended rate of £92,400. His taxable income is still £48,525, so anything equal or below that would still be taxed at 20%
What happens to the remaining £10,000 unrelieved from tax? Good question!
I kind of agree with you on taxing it at 40% but I haven’t come across an example like this before in practice so I need to look into it first before making any assumptions.Here’s what i do know:
If an individual was to make personal pension contributions in excess of his UK relevant earnings he would need to notify the scheme administrator. These contributions do not count towards the annual allowance limit (£245,000), but will affect the value of the pension fund for the lifetime allowance (£1,750,000).Ya that’s what the BPP books says as well but doesnt go in much detail. And I guess since we have seen the example, it’s enough now as it’s not like we are going to get zero if I make one or 2 mistakes in a question.
Thankz alot for your help.
Ok the £10,000 is ignored because pension is not taxable, however it’s benefits are that it relieves on income tax. I can’t believe it’s so simple yet i spent ages confused. Your reply was so cleverly written that I started thinking like you 🙂 Good luck
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@acltang72 i thought when we extend the band to 92,400 we deduct PA and the remaining amount we tax at 20%? Am i missing something here?
Anything equal or below the extended rate band of £92,400 is taxed at 20%. Anything above is taxed at 40%. We don’t deduct the personal allowance from this figure. The basic rate band extension has nothing to do with the computation and is only used to work out the tax liability and therefore tax payable.
Just incase I misunderstood your question you can post an example of how you think the question should be treated and I will take a look
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Got it mate thanks appreciate your quick response
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