how to earn £1500+ per hour – claim back tax on your SIPP contributions
The headline may sound unbelievable, but it’s actually true, I did “earn” just over £3000 the other night simply by filling out my self assessed tax form to claim the tax back on my SIPP (Self Invested Personal Pension) contributions for the previous tax year – See the screen shot of my final pay out above to prove this!
I genuinely thought it would take me about a week of head scratching and article reading to get my head round all the complications, find the relevant documents and so on, but it was in fact surprisingly easy. In total I would say that it took me around 2 hours of actual form filling in (and next year this will be even quicker!) so that makes my effective hourly rate:
Needless to say I think this is the highest hourly rate I have ever achieved for what could be considered “work” 1
If you have never done a tax return before I’ll take you through the whole process from start to finish in part two of this post, but first of all in part one let’s just talk about the wonderful thing that is the SIPP.
the great “British SIPP tax-break” off*
*Sorry, that was bad even for my standards!
SIPPs are bloody great. The main benefit is that you get tax relief automatically added when you stuff some money into it at the standard 20% rate, and if you are in a higher rate tax bracket then you can claim further relief via the self assessment tax form as we have discussed above. The total tax relief you will receive is therefore up to 45%!
Even better, the way this works is most probably slightly different from how you would imagine with your first back of the envelope calculation, an example best illustrates this:
Say I put in £8,000 2 – You might initially think that your tax break would be added by simply multiplying the £8k by 20% so you would get £1,600 added into your account. WRONG! They actually assume that your contribution is the part you wanted to put in after tax has already been taken off.
So in our example they will assume that if you were a 20% tax payer you actually wanted to put a total of X where X = £8k * (1 – 0.2) – in other words just divide you initial amount by 0.8 to get your “total contribution”. Maybe it’s easier to think about from the reverse perspective once you know your total amount after tax relief:
Total amount = £8K / 0.8 = £10,000
The reverse calculation: £10,000 * 20% = £2,000 – So now you can see why that is the amount that gets added to your initial £8k contribution 3
In other words the rule is:
If you are on 20% tax rate your initial contribution actually gets a boost of 25%!
If you are on a 40% tax rate this works out even better, and some of you may already be one step ahead of me here and thinking you just divide your £8k by 0.6 (1 – 0.4) to get your final contribution
Total amount = 8k / 0.6 = £13,333 – This means your own contribution is boosted by a whopping 66%
Not so fast, poindexter…. 🙂
Actually, in practice this is not quite the way it works. Don’t worry, you still get the 66% boost on your total money in as you would expect, but because for anything above the 20% you actually claim the tax back, rather than get the instant boost to the contribution, the figures are slightly different, just to make things more confusing for you.
So now what the government do is assume that the total contribution you wanted to make was in fact, in our example, the £10K amount that is in your account (after the initial 25% boost). They then work out what you are owed to get you back down to the correct amount of tax relief of 40% on that £10k contribution:
£10k total contributions * 40% = £4,000 of total tax relief to be given.
Total tax relief already given = £2,000 therefore the tax rebate you will receive is obviously just £4k – £2k = £2,000.
That was simply a long winded way of saying the rule is:
If you are on 40% tax rate you will receive a tax rebate equal to the amount the initial contribution gets boosted by!
As mentioned earlier you can now see that the total “boost” to the SIPP fund, in comparison to the amount you are actually out of pocket for (i.e. your net contribution) is, in our example:
Net contribution £6,000 / Total money in SIPP £10,000 = 66% boost 🙂
If you wanted to work out the 45% tax situation you should be able to do it yourself now or if not you can probably afford an IFA to do it for you 😉
So there you have it, the great SIPP tax break explained in some easy to follow(!?) examples!
If I’ve just confused the hell out of you, or you just wanted to play around with some values and see how much you could claim back, this calculator from HL is really great to see how the values of contributions and tax relief all work out.
woah there, newly anointed SIPP fans…
Before you plow all of your spare cash into a SIPP, there are a few fairly large downsides of a SIPP which we mustn’t forget:
- You can’t access any of the funds until you approach traditional retirement age – 55/56/57 and rising depending on how the government is feeling each budget and your year of birth.
- On current rules, you will get taxed on the money on withdrawal like income so if you are planning on having a £100,000/year draw down, the tax breaks are kind of nullified somewhat – should not apply to most readers of this blog!
- The government has fiddled with the rules on SIPPs and general taxation and will no doubt will fiddle again in the future, so with a 20+ year horizon this is a definite unknown risk. It therefore makes sense to spread your investments around into ISAs and other investment vehicles rather than sticking everything in one place.
- You can only claim the higher rate refief on earnings over the limit. So let’s say you conveniently earn £52,386 per year, and stuck £20K into your SIPP, you can only claim extra relief on £10K of that – due to the higher rate tax bracket being £42,386. (Thanks to commenter Dragon for pointing out that I’d missed out this crucial peice of info!)
For more information see the great Monevator post on ISAs vs SIPPs.
The final “downside” of the SIPP is that if you are on any of the higher rate tax bands you have to claim the extra relief yourself, which brings us neatly onto…
part deux – le self assessment tax return
This post, as is often the case, has gotten quite long and I prefer my posts to be bite sized chunks of financial goodness rather than a long slog of boredom, so will break out the second part of how to fill in your tax return to actually get the tax back.
Sorry to folks only on the 20% tax bracket, but part two will not apply to you. The good news is that you don’t have to bother doing anything to get your 25% boost on contributed funds, you just stick the money in, your SIPP provider will apply to HMRC on your behalf, and a month or so down the line it will just appear like magic in your account for you to invest wherever you would like. Bonus!
Have a great weekend and see you in a few days for part deux…. 😉
- I am defining work by somewhat rudimentary terms of something that is a bit boring that most people would rather not do here 🙂 ↩
- You will see why I chose this amount in a minute, as it makes the figures all nice and round ↩
- Hopefully… if I’ve made things clear? As mud no doubt! As usual if you aren’t sure of anything give me a shout in the comments. ↩