?Tax Credit gain & Cheap Pension loophole??

sneekymum · 16 May 2005 at 10:15AM

I asked this question and got a straight answer which I posted further down this thread....

"We're a self-employed couple with three children. We get Tax Credits based on our family income of around £17,000.

We have no pensions and so we were thinking of getting Stakeholder Pensions this year. I know that we could make contributions now to be counted for last year. (This is the last year in which this is allowed).

Would this reduce our income for the last tax year so that we would get more Tax Credit? I understand that making that pension payment during the last tax year would have had that effect. Does it have to be actual money we earned or could we borrow it to do this? It seems that mega tax savings are possible here."

Cook_County · 16 May 2005 at 8:10PM

I have done this myself and doubled the money - but then I had to do a lot of work first to have the children so couldn't afford the pension

isasmurf · 16 May 2005 at 9:37PM

Have a read of this thread on the Pensions Board. It may answer your questions.

ctm_2 · 16 May 2005 at 10:52PM

I don't think you would actually benefit from anything, as with a combined income of £17000, you are nowhere near the 40% tax bracket. Most pension contributions have already had releif at 22%, so extra would only arise if you were a higher rate taxpayer.

sneekymum · 16 May 2005 at 11:44PM

Yes but Tax Credits are increased by 37p for every pound of lost earnings in contributions towards pension (down to a floor of £13,480). - then add on the 22% to gross up the contribution. There might be 77% benefits to higher tax payers but there's over 103% to the low paid too.

e.g. pay £2,808 into a stakeholder pension giving you £3,600 worth of pension
get 37p in the pound Tax Credits for reducing your earnings - that's £1,039 "cash back".
So, this £3,600 worth of pension cost just £1,769
a 103% tax gain.

Cook_County · 17 May 2005 at 9:43AM

http://www.hmrc.gov.uk/manuals/ntcmanual/

sneekymum · 17 May 2005 at 12:44PM

I asked TaxAid - they replied

"Thank you for contacting TaxAid.
You are correct that for income tax purposes you can in some
circumstances elect to carry back payments into personal pension
plans against income of the previous tax year. You need to specify
to your Pension Provider BEFORE you make the payment
that you want to treat this payment as made for the last tax year.
You can only do this up until 31 January in the next year.
The time limits for the claim for income tax are set out at
this link on the Inland Revenue website
http://www.hmrc.gov.uk/manuals/sam/samrpt/samrpt09116.htm

However for Tax Credit purposes, the legislation says that when you work
out your income for Tax Credits you can deduct 'the amount of any
contribution (to a qualifying personal pension scheme) made by the
claimant (or each of the joint claimants).' It doesn't allow the same sort
of carry back that you can make for income tax.

This is because in the earlier tax year the contributions weren't 'made' (the tax
law for income tax just treats them as if they were made in that year).
So you can't use reduce your last year's income for tax credits by contributions
made now.

In general, payments into personal pension plans can be deducted from
your income for tax credits - but only the amounts you have paid in the year.
http://www.hmrc.gov.uk/manuals/tctmanual/tctm04002.htm
The amount to be deducted is the GROSS amount of the personal pension
payment. This is the amount you pay, plus the 22% tax relief which
the government pays into your pension plan. (You can calculate this
as: (amount you pay) x (100/78).

It doesn't matter where you find the money to pay into your personal pension
plan. There are limits to the amount you can pay in, by reference to earnings.
These rules are quite complicated - but anyone can pay in £2808 (that is, £3600
gross), whether or not they have any earnings. Above this amount the proportion
of your earnings you can pay increases with age - your pension scheme can advise about limits.

Once you have made your annual declaration of last year's income, you can
let TCO know if your income in the current year (05/06) will be lower
than last year (eg, because of the pension payments). They will recalculate
your award for 05/06 based on the lower estimated income so that you get
more tax credits now, rather than have to wait till after April 2006 to get
the higher award. Of course, if your self-employment income goes up in the
meantime, you could be overpaid.

I hope this helps."

Yes - it does, thanks!:j

sneekymum · 4 June 2005 at 9:25AM

Greetings to anyone ariving here from the self emplyed pensions options?

Here is my further eMail to TaxAid

If my mother gives us £11,232 to put into pensions (for me & my husband) to
count as this year's contribution and last years (4 x £2,808) we'll have
pension funds totalling £14,400 after tax back at 22% - but Tax Credits will
refund us at 37p in the pound on our £11,232 even if we still earn £17,000 -
that's £4,155 Tax Credit because of a pension contribution.
This would mean we bought £14,400 worth of pension for just £7,077 - a tax
gain of over 103%
and we'd still be in the same position for Tax Credits on our earned income
of £17,000 as we were before we started.
This all sounds too good to be true. Am I missing something?

and their reply

1) Up to the £2808 (net) it doesn't matter where the money comes from.
Over that, it does need to be related to earnings. As you say, the government will add
tax of £792 for each £2808 contributed to the pension plan, so between you
you would have pension 'pots' of £14,400. As before, you do need to arrange
with the pension provider BEFORE you make the payment that the initial
payments are to be carried back to the previous year.
2) For tax credits, when you declare your income for the year (which affects
the amount of tax credits you are paid) you deduct the GROSS amount of pension
payments (to approved schemes) made in the year.
http://www.hmrc.gov.uk/manuals/tctmanual/TCTM04002.htm
So if your income remains at £17000, you can deduct £14,400 from the income
you declare for tax credits - leaving income of £2600. In 2004/05 your tax
credits award is not reduced if your income is below £5220. But if you are
receiving WTC or CTC, the reduction is 37p for every pound over that.
So the saving would be 37% of (17000-5220)- that is £4358.
You are right that in principal you save 37% of £14400 (so £5328) but only
if your income is high enough for all the £14400 to be taken off without
going below the 'threshold' at £5220. Any reduction below this amount
won't add extra savings.
The savings you make are a result of the fact that, if you are getting WTC/CTC
at more than the 'family element', you are paying tax/losing tax credits at
a rate of 59% (and if you add in national insurance, it brings it up to 70%).
So any tax saving is correspondingly large.
As you say, for £6874 of 'real' after tax money, you will build a pension
pot of £14400.
3) To get the adjustment to your tax credits immediately you will need to let
the Inland Revenue know that your income for 05/06 will go down because of
pension payments made. There is no advantage to you to advise of income less
than £5220.
4) You need to be careful if next year (2006/07) you only pay one pension
payment (£2808) or none. Your tax credit award will start off based on
this year's low income. So you could be paid too much at the beginning.
To avoid getting overpayments, you will need either to let the Inland Revenue
know soon after 6 April 2006 that your income (for 06/07!) will be higher,
or send back your renewal/annual declaration form very promptly.

sneekymum · 4 June 2005 at 9:32AM

Not enough people know about this.

dunstonh · 4 June 2005 at 12:14PM

I know. When i started the original thread back in the pensions forum, it got very little attention.

In simple terms, a higher rate tax payer can potentially get upto 77% tax relief and then in retirement take 25% tax free lump sum back, meaning that basically, the Govt has paid for their personal pension contributions.

I havent read anything yet on how the new contribution levels coming in April 2006 will impact on tax credits. From next year you will be able to pay 100% of your income into a pension and not have the current age percentage limits.

If the tax credit rules remain unchanged, you could invest in a pension, as an investment (many people do. Its not just for retirement, they can make good investments too). That investment could wipe out your income, or at least reduce it significantly giving you a significant payment in working/childrens tax credits.

Example. couple in 30s with 2 children at school. Both earn £15k a year.

They have £30,000 to invest. First gain is that it only costs them £23,400. They can put the other £6,600 into ISAs. They should invest it equally between them (like most retirement planning should be). Therefore their income of 15,000 is wiped out by 15,000 each contributions.

As they are zero earners, they get £1878.84 in child tax credit and £3249.72 in working tax credit. Making a total of £5128.56.

So, their 30k investment initially cost them £23,400. Then they get paid £5128.56 in tax credits meaning the investment has only really cost them £18,271.44. In the space of upto 12 months, they would have only effectively paid £18,271 but it would be worth over £30k.

Potentially, 30k gross invested in early 30s would mean you wouldnt have to pay into a pension again.

sneekymum · 4 June 2005 at 1:28PM

Yes I was wondering about next year too - I could easily start syphoning my 'maturing' PETs into pensions and become very 'income-poor'.

I think people see Tax Credits as some kind of 'benefit' & any sneeky ways to get more seem illegal. Perhaps the government want us to think this. To me its just another tax ball to juggle.

?Tax Credit gain & Cheap Pension loophole??

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