simple pension question

davey9998

for simplicity lets assume the 40% tax bracket comes in when you earn £40,000 per year.

if then you earnt £42,000 per year your savings would be taxed at 40%.

If you put £2,000 into your pension you would get 20% relief at source and a further 20% through your tax return.

If you say put £3,000 into your pension would you only get 40% on £2,000 and 20% on £1,000?

Also, if you say put £5,000 in your pension you would effectively pay £37,000 worth of income tax. Therefore, assuming your interest on savings was less than £3,000 would you only pay 20% tax on your savings.

what i am saying effectively is can someone pay whatever they earn above the higher rate threshold into a pension and therefore avoid the 40% tax on savings as their income would be then less than the higher rate threshold?

MrMicawber_2

No - your income is still higher rate. The pension relief doesn't 'reduce' your income it is just a tax benefit of investing in pensions.

CLAPTON

Yes

if you pay the excess of your income (salary plus gross interest) over the (notional) 40k into your pension then effectively none of your income is taxed at 40%... as the tax relief you receive on your pension will be at your highest rate i.e. it's deducted before tax is calculated

davey9998

thanks that reaffirms my thoughts

MrMicawber_2

Are you 100% sure on that - apologies assuming I'm wrong. I've never heard of this 'knock on' means of avoidance.

CLAPTON

there is no avoidance it just works like this:

assume you have an income from earnings of 45,000
and gross interest of 2,000

then normally you would pay as follows
total income 47,000
less personal allowance of 6035
is 40,965
of which 34,800 is taxed at 20% i.e. tax of 6960
so 6165 is taxed at 40% i.e. 2466
total tax to pay is 9426
in practice some will already have been paid on the interest (20% of 2000 i.e. 400 )


now if you pay say 6165 into a pension (grossed up if necesary)

then it works like this
gross income 47,000 as before
less pension of 6165 (grossed up in not an occupational scheme)
i.e. taxable pay 40,835
less 6035 tax free
i.e. 34,800
which is all at 20%


It's particularly noticable if you are in an occupational pension scheme where the pension is deducted first then everything is worked out on the 'taxable' income... indeed the gross salary doesn't even appear on the P60; only the taxable

MrMicawber_2

Thanks - I'm with you now - and many apologies for jumping in with both feet and being wong on this.

jem16

davey9998 wrote: »

what i am saying effectively is can someone pay whatever they earn above the higher rate threshold into a pension and therefore avoid the 40% tax on savings as their income would be then less than the higher rate threshold?

As Calpton has pointed out yes you can. I have been doing exactly that for the last two years.