Going backwards with tax, isn't the same as going forwards

I have struggled to explain this in words quite a few times to my friends and family. But I'm hoping it will be easier with the facts and figures.

In the U.K we have four tax bands (as of the time of writing)

This just means, depending on what you earn depends on what you pay tax on. If you earn more, you should pay more tax. Unless you earn LOTS MORE, and then you run the money through offshore tax havens, and pay zero tax.

But for the rest of us, there are 4 tax bands.

Why are you telling me this?

Because there are some investments you can make, where you can claim the tax you paid back!

Have you ever felt disheartened hoping to be paid £2,000 this month, only for it to be much less, due to tax, for example?

Well, if you were to put that money into your pension, you could claim back the tax relief.

Let's say for example you're a 20% tax payer on the sum, when you hear this good news, you may jump up and down in sheer delight and think "I'm going to get 20% of my money back!" - but oh boy, do I have some good news for you.

You will get more than 20% back! You will get even more back!!

HOW?!?!

When you get some money in your payslip, going forward with your tax (working out your tax from your salary) is very easy.

You get paid £100 - you pay 20% tax (for example), then it's nice and easy, you get £80 net.

But going backwards with your tax (trying to work out tax relief on your money you put into a pension), the percentages all change.

If you got paid £80 and you simply worked out 20% of your salary, to try and calculate your tax relief:

£80 + 20% of £80 (£16) = £96

Wait. Where did the missing £4 go? You started with £100 and now you only have £96 with the tax relief %'s we've discussed.

Going backwards with your tax works out to a larger percentage (25%) because you've ALREADY been taxed. You can't just simply work out the gross %'s from the net money in your salary.

It's the same for all the other bands too. You will end up with more.

£80 + 25% of £80 (£20) = £100

Example continued

If you're lucky enough to be a 40% tax payer for example, whatever salary sacrifice you put into your pension, will actually work out to be about 67% of your money back.

Think about how insane that is.

You put £1,000 into a pension, and gained £1,670. Just in tax relief, let alone the investment growth of your money.

For investing and growing your money - putting your money into a tax advantaged account (like a pension) is an insanely powerful way for it to grow.

The tax relief you receive on your money ends up looking something like the below for the different bands:

Conclusion

I hope this article has helped to clear up any confusion with tax relief being calculated.

It feels like a boring choice of your money to put it into your pension, but you don't have to put in much monthly for it to work out to a serious sum.

Drop a comment if something doesn't make sense and I'll amend the article!