As we draw ever closer to the end of the tax year it is worthwhile considering how pension contributions can be highly tax efficient in a wide range of circumstances. In this post I have listed different scenarios in which a pension contribution may be beneficial.
Pension legislation is complicated so it is important to seek professional advice before you commit any money to a pension. This article is not advice because it doesn’t take your personal circumstances into consideration. If you would like to discuss this topic (or another topic) with one of our advisers please call 01642 477758 or visit our Contact page.
The current tax year ends on 5th April 2017 so, if you wish to discuss the potential benefits of making a pension contribution, please arrange an appointment as soon as possible.
List of relevant scenarios
Click on one of these links (or simply scroll down the page) to read how a pension contribution may benefit someone in the following scenarios:
- Someone who received a taxable redundancy payment
- Someone who might be liable to the Child Benefit charge
- Someone who might be subject to the Tapered Annual Allowance
- Someone who might lose their Personal Allowance
- A company owner/director who expects to pay corporation tax
- Someone who expects to pay higher rate or additional rate income tax or Capital Gains Tax
- Someone who expects to pay Inheritance Tax
1. Someone who received a taxable redundancy payment
Generally the first £30,000 of a payment redundancy payment is tax-free but any balance over this amount is taxable. This can easily push someone from their current tax bracket into a higher tax bracket.
It is possible to make a lump sum pension contribution in the same tax year as you receive taxable redundancy pay and benefit from income tax relief. Depending on your total taxable income and the lump sum you have available this could result in income tax relief of 20%, 40% or even 45%.
2. Someone who might be liable to the Child Benefit charge
In the 2016-17 tax year, anyone who receives Child Benefit and earns over £50,000 will pay a tax charge. This is paid via a tax return, so anyone who expects to pay this charge (which is called the “High Income Child Benefit Tax Charge”) must register for self-assessment and complete a tax return.
The tax charge is equivalent to the amount of Child Benefit you receive multiplied by the amount your income exceeds the £50,000 limit, divided by 10,000. This is confusing so I have included an example: if you have an income of £52,000 and you receive £1,076.40 Child Benefit the tax charge is £1,076.40 x (£52,000 – £50,000) / 10,000 which is £1,076.40 x 20% = £215.
If you wish to avoid losing some or all of your Child Benefit you can make a lump sum contribution to a pension. This reduces or removes the tax charge because the charge is calculated based on your “adjusted net income”, which is essentially your earnings minus pension contributions and some charitable contributions. If your “adjusted net income” falls below the £50,000 threshold you should not be liable to pay the Child Benefit tax charge.
3. Someone who might be subject to the Tapered Annual Allowance
In the 2016-17 tax year, anyone with a higher income may face a reduced Annual Allowance, called the Tapered Annual Allowance. These allowances are covered in more detail at the following links: Annual Allowance and Tapered Annual Allowance.
If your “Threshold Income” is expected to be greater than £110,000 you can make a pension contribution to take your Threshold Income below this limit. It is vital to seek advice from both a financial adviser and an accountant regarding the Tapered Annual Allowance otherwise you could easily find yourself liable to pay an Annual Allowance Charge, which can be up to 45% of the pension contribution amount.
4. Someone who might lose their Personal Allowance
If your earnings go above £100,000 you will start to lose your Personal Allowance. This highly valuable allowance is the amount you can earn without paying income tax. For most people it is £11,000 in the 2016-17 tax year. The Personal Allowance is taken away by £1 for every £2 your income exceeds the £100,000 threshold. For example if you earn £105,000 before allowances you will lose £2,500 of your Personal Allowance, leaving you with a tax-free limit of just £8,500. If your income is £122,000 you will lose the full Personal Allowance (the Personal Allowance is reduced by: £122,000 – £100,000 / 2 = £11,000). If your income is between £100,000 and £122,000 the effective rate of tax you pay on your income above £100,000 is 60%.
In a similar way to the High Income Child Benefit Tax Charge (see scenario 3), the Personal Allowance is only taken away if your income minus pension contributions (and some charitable contributions) exceeds £100,000. This means you could reduce your income to below £100,000 and keep your full Personal Allowance.
5. A company owner/director who expects to pay corporation tax
If you both own and work for your own Limited company you may be able to make a pension contribution from your business and claim it as an expense before corporation tax is calculated. The rules around this are somewhat vague though, so it is vital to speak to both a financial adviser and your accountant before you make a pension contribution in this scenario. Ultimately if HMRC decide the pension contribution was not made “wholly and exclusively” for the purposes of business then HMRC may not allow the company to claim corporation tax relief on the contribution.
If your accountant says a pension contribution will be worthwhile it is a great way of building up your own personal retirement savings while also mitigating your corporation tax bill.
6. Someone who expects to pay higher rate or additional rate income tax or Capital Gains Tax
Broadly speaking, if your earnings plus any taxable capital gains* is more than £43,000 in the current tax year you will pay higher rate tax. If it is more than £150,000 you will pay additional rate tax.
You pay different rates of tax for income and capital gains as shown in the following table:[table “” not found /]
Making a pension contribution normally allows some of your income and/or taxable Capital Gains to be pushed out of a higher rate tax bracket and into a lower rate tax bracket.
* Taxable capital gains means the disposal proceeds of an asset less the purchase price less certain allowances (including the Capital Gains Tax Allowance of £11,100 in the 2016-17 tax year).
7. Someone who expects to pay Inheritance Tax
Inheritance Tax is payable at a rate of 40% if someone’s estate exceeds the allowances available on death. Pensions are one of only a handful of assets which are normally not included in the value of someone’s estate for Inheritance Tax purposes. So, if you are considering saving for your future and you expect your estate will be subject to Inheritance Tax it might be worthwhile considering saving into a pension rather than another type of financial product.
The maximum you can contribute to a personal pension each tax year (and still receive income tax relief) is the lower of:
- Your Annual Allowance: this is normally £40,000 per tax year but if you are subject to the Tapered Annual Allowance or the Money Purchase Annual Allowance your limit will be less than this
- Your relevant UK earnings: this includes salary but it does not include pension income, rental income or dividend income (amongst other types of income)
- A fixed amount of £3,600
Each of these figures is quoted after tax relief is given. For example someone without any relevant UK earnings can contribute a maximum of £3,600 including tax relief. This is equivalent to £2,880 before tax relief is added.
As stated at the head of this article (and as demonstrated in the article itself) pension legislation is complex and it is very easy to fall foul of the rules without professional advice. If you would like to book a free initial meeting with one of our advisers please call 01642 477758 or visit our Contact page.