ACCA Advanced Taxation (ATX) Practice Exam

Do personal pension contributions extend the basic and higher rate tax bands?

1. Yes, they do

2. No, they do not

3. Only for basic rate taxpayers

4. Only if contributions are above a certain limit

The correct answer is: Yes, they do

Personal pension contributions do indeed have the effect of extending the basic and higher rate tax bands. When individuals make contributions to a pension scheme, these contributions are considered as relief from income tax. Specifically, they effectively reduce the individual's taxable income, which can allow more of their income to fall within the lower tax bands. By contributing to a personal pension, a taxpayer can therefore increase the amount they can earn before they start moving into the higher rate of tax. This increase can be quite significant for those individuals who are close to the threshold of these bands. For example, if a higher rate taxpayer contributes a substantial amount to their pension, it could reduce their taxable income to a point where a greater portion of their earnings is taxed at the basic rate rather than the higher rate. This beneficial treatment not only assists individuals in saving for retirement but is also an effective tax planning strategy, allowing taxpayers to maximize their income retention by minimizing the tax burden within these bands. Thus, personal pension contributions play a crucial role in tax efficiency for many individuals.