They are doing this because people don’t understand how tax relief works on pension contributions. This is backed up by a recent survey which found that people don’t understand how pensions work. We can go a step further and say that most people don’t understand the deductions on their payslip and how it works.
With auto enrolment, the effective tax relief is 30% for everyone, so it isn’t good for higher tax payers and more beneficial for lower tax payers. How is pension tax relief applied?
PAYE workers can have their pension contribution deducted from their pay before they are taxed. We call this getting tax relief “at source”. It is very convenient as you get tax relief immediately and don’t have to deal with the Revenue regarding refunds. If you are self employed, while the tax relief is the same, preliminary tax also comes into play. Luckily, I wrote about this all the way back in 2014.
Higher tax payer
Sam earns €72,000 a year and doesn’t contribute to a pension. What does his monthly income tax look like? Pension contributions are subject to PRSI and USC, so I am only going to look at income tax. As a single person, Sam can earn €44,000 (€3,666.67 a month) at 20% income tax and the remainder at 40%. He also gets €4,000 in tax credits (€333.33 a month).
| Gross Salary | 6,000 | ||
| Pension | 0.00 | ||
| Income Liable for Income Tax | 6,000 | ||
| Tax at 20% (€3,666.67) | 733.33 | ||
| Tax at 40% (€333.33( | 933.33 | ||
| Less Tax Credits | -333.00 | ||
| Total income tax paid | 1,333.34 |
His colleague Kate, earns the same salary as Sam but she contributes €500 a month into her pension. Kate’s pension contribution is deducted from her salary before income tax is calculated. As she is a higher tax payer, her €500 contribution gets 40% tax relief i.e. €200, which is the difference in income tax paid between her and Sam.
| Gross Salary | 6,000 | ||
| Pension | 500 | ||
| Income Liable for Income Tax | 5,500 | ||
| Tax at 20% (€3,666.67) | 733.33 | ||
| Tax at 40% (€333.33( | 733.33 | 1,466.67 | |
| Less Tax Credits | -333.33 | 1,133.34 |
Just about in the higher tax bracket
Roisin earns €48,000 and doesn’t contribute to a pension. What does her income tax look like?
| Gross Salary | 4,000 | ||
| Pension | 0 | ||
| Income Liable for Income Tax | 4,000 | ||
| Tax at 20% (€3,666.67) | 733.33 | ||
| Tax at 40% (€333.33( | 133.33 | ||
| Less Tax Credits | -333.33 | 533.34 |
Her colleague Peter also earns €48,000 but he contributes €500 a month to a pension. But he won’t get all of his tax relief at 40%, just the amount of that brings him into the higher tax bracket. In other words, €333.33 of his pension contribution gets relief at 40% and the remaining €166.67 gets relief at 20%.
| Gross Salary | 4,000 | ||
| Pension | 500 | ||
| Income Liable for Income Tax | 3,500 | ||
| Tax at 20% (€3,666.67) | 700.00 | ||
| Tax at 40% (€333.33( | 0 | ||
| Less Tax Credits | -333.33 | 366.67 |
Payslips and tax relief isn’t fun and it isn’t exciting. Most people receive payslips every week or month for 40 years of their lives and don’t understand the figures on them. It is important that you do.
By Steven Barrett
