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Key takeaways
- Pension contributions made under relief at source extend income tax bands.
- Extending tax bands can reduce the rate at which capital gains are taxed.
- Contributions also receive tax relief, adding further value.
1. When CGT applies
CGT applies where a client’s gains on a capital asset such as property or shares etc., exceeds the annual exempt amount of £3,000. Previous years' unused losses can be offset.
2. CGT rates
When gains exceed the exemption, they are taxed at:
- 18% for non‑taxpayers and basic rate taxpayers.
- 24% for higher and additional rate taxpayers.
Where gains sit across bands, some are taxed at 18% and some at 24%.
3. Extending income tax bands
Relief at source pension contributions receive:
- Immediate 20% basic rate relief added by the scheme, for example an £8,000 net contribution becomes £10,000 in the pension.
- Further higher or additional rate relief delivered through extended income tax bands.
The gross contribution extends the basic rate tax bands and any tax bands above that.
If a person living in England, were to make an £8,000 net contribution which is then grossed up to £10,000 within the scheme, the basic rate band increases from £37,700 to £47,700. As a result £10,000 more income would then be taxed at 20% rather than being taxed at the higher rate of 40%.
The relief at source gross contribution would also reduce the adjusted net income, which may help clients regain some or all of their personal allowance or reduce a high‑income child benefit charge.
4. Why this reduces CGT
CGT is tied to income tax thresholds. By extending the basic rate band and any subsequent tax bands, more of the gain may fall within the lower CGT rate (18%) rather than the higher rate (24%).
This effectively reduces the tax bill on gains realised in the same tax year.
5. Basic planning points
This planning works best when the client:
- Is eligible to make a relief at source contribution.
- Has enough annual allowance remaining.
- Has sufficient relevant UK earnings to be able to make the proposed amount of personal contribution
- Has funds available (sale proceeds from the asset sold can be used).
6. Examples
Income: £45,270
The higher rate tax band starts at £50,270 which means the remaining amount of the basic rate tax band is £5,000.
Capital gain: £10,000
CGT calculation with no pension contribution
- £5,000 x 18% = £900
- £5,000 x 24% = £1,200
- Total CGT = £2,100
Personal contribution: £4,000 net/£5,000 gross
This extends the basic rate tax band by £5,000, so the higher rate tax band now starts at £55,270. With income of £45,270 the remaining basic rate tax band becomes £10,000.
CGT calculation after the pension contribution
- £10,000 x 18% = £1,800
Tax saving
- Before contribution: £2,100
- After contribution: £1,800
- Saving = £300
Income: £110,000
At this income level the personal allowance is reduced.
For every £2 of income above £100,000, £1 of personal allowance is lost.
Income above the threshold: £10,000
Reduction: £10,000 ÷ 2 = £5,000
Remaining personal allowance: £12,570 − £5,000 = £7,570
Capital gain: £30,000
Because the client is already within the higher rate tax band and has reduced personal allowance, the gain is fully taxed at higher CGT rates.
CGT calculation with no pension contribution
- £30,000 x 24% = £7,200
Personal contribution: £72,000 net/£90,000 gross
This contribution extends the basic rate band by £90,000.
It also reduces the adjusted net income from £110,000 to £20,000, which is well below the £100,000 threshold, so the full £12,570 personal allowance is restored. Meaning the £5,000 will now be tax at 20% instead of 40%.
The restoration of the personal allowance means the higher rate threshold now sits at £140,270 (£12,570 plus £37,700 plus £90,000). For someone with income of £110,000, the remaining portion of the basic rate band is £30,270 (£140,270 minus £110,000).
CGT calculation after the pension contribution
- £30,000 x 18% = £9,000
Tax saving
- Before contribution: £7,200
- After contribution: £5,400
- Income tax saving due to restoration of personal allowance: £1,000 (£5,000 x 20%
- Saving = £2,800
Higher rate tax relief of £18,000 will also be able to be reclaimed via self-assessment. This example assumes that the client has sufficient annual allowance and carry forward to be able to make this contribution.
The information provided in this article is not intended to offer advice.
It is based on Quilter's interpretation of the relevant law and is correct at the date shown. While we believe this interpretation to be correct, we cannot guarantee it. Quilter cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.