Paying a lump sum into pension tax-efficiently

BTL_Reading · 20 November 2017 at 7:52PM

Hi all - I'd like to clarify my understanding (or lack thereof) of how pension payments interact with income tax.

Let's say I earn £50k a year, so taxed at 40% on £5k and 20% on most of the rest.

I have £7k of 'spare' money, and would like to pay into a pension in a tax efficient way.

My understanding is this: if I were to pay £3k into my pension, I would get a rebate of £2k of tax from that (I earned £5k, then paid 40% in tax on it, left with £3k, then paid that into pension, so claiming the £2k as rebate). £1k of that rebate would be claimed by pension company, £1k claimed back through self assesment. Then the next year I could do the same and the final year pay in £1k, for a total of £4.6k

Or, if I were to pay all £7k into pension in a single year, I'd get a rebate of £3k - £2k due to the mechanism above, but then only £1k on the remaining £4k since I've used up my 40% allowance (I earned £5k but paid only 20% in tax on that earning).

In other words, to pay a lump sum into a pension it's more tax efficient to pay into pension as much as 'uses up' the 40% tax portion of my income, and to keep doing that year on year until it's used up.

Is my logic sound, or what have I missed?

Thanks,
Oli

00ec25 · 20 November 2017 at 8:46PM

depends to an extent on the origin of this "spare" money, for example, going by your user name, if it is profit from letting then no it can't be paid into a pension because it is not "relevant earnings"
http://www.rossmartin.co.uk/private-client-a-estate-planning/income-losses-claims-reliefs/1034-relevant-earnings-for-pensions-purposes

see section "earnings that attract tax relief"
https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100#earnings

so, in your case you have 50k of relevant earnings, of which 5k could get higher rate tax relief

BTL_Reading · 20 November 2017 at 8:58PM

Thanks 00ec25, well spotted!

But in this case it's not BTL related, the £50k is salary and the £7k is sale of shares (given as grant from employer, tax previously paid).

00ec25 · 20 November 2017 at 10:25PM

BTL_Reading wrote: »

the £7k is sale of shares (given as grant from employer, tax previously paid).

taxed to CGT or income tax?

BTL_Reading · 20 November 2017 at 11:15PM

00ec25 wrote: »

taxed to CGT or income tax?

Income at the time they were vested. Sale price just under the vesting price so no CGT to pay.

Dazed_and_confused · 20 November 2017 at 11:24PM

Op,

Your numbers don't make a lot of sense to me sorry.

Assuming your are talking about a personal pension or sipp then you get basic rate tax relief at source on what you pay and the gross amount increases the amount of basic rate tax you pay, which for a higher rate payer reduces the 40% tax payable.

Current tax year example,

You make payment of £4000 into personal pension or sipp.
Pension provider adds basic rate tax relief of £1000 so you have £5000 in your pension fund
You tell HMRC about the payment (£5000 gross amount) and they increase the amount of 20% tax you can pay from £33500 to £38500 (or £31500 to £36500 in Scotland)

Depending on your total taxable income this could reduce the tax you have to pay by another £1000 (you have to pay 20% on £5000 instead of 40% on the £5000).

Overall result is you have £5000 in your pension fund which ultimately cost you £3000 (assuming you have sufficient income to get the full higher rate tax relief) but this does start with a £4000 payment to the pension provider.

BTL_Reading · 20 November 2017 at 11:44PM

Thanks 'Dazed and confused', that's very helpful. I conflating the tax relief given to me with the tax relief the pension company adds into the fund.

But I think you've confirmed my original idea (albeit with my wrong numbers) that for a higher rate tax payer, as I increase the amount I pay into pension in any one year , there comes a point when it becomes less profitable - when you say "Depending on your total taxable income this could reduce the tax you have to pay" that only applies if I'm still paying any 40% tax, so spreading a lump over several years will be more tax efficient.

Dazed_and_confused · 20 November 2017 at 11:52PM

It tends to vary. Threads on here (Cutting Tax board) are often about getting maximum tax relief at 40% (or in the child benefit or personal allowance clawback range) whereas on the Pensions board there is more interest in what the maximum you pay in to get any tax relief at all.

But basically yes, once you have got out of the 40% bracket then generally you are only getting the basic rate relief the provider adds and there is no extra personal tax saving for you.

Judging exactly what to pay can be tricky given you may not know your taxable salary until your March payslip is available. And then you have other income such as savings interest, company benefits or dividends to consider.

Paying a lump sum into pension tax-efficiently

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