Maximising 40% tax relief on pension contributions

Wilma33

Hi

I am considering paying a lump sum into my pension this tax year in order to maximise the 40% tax relief on pension contributions for higher rate tax payers. I need some help working out how much I should pay in.

I realise the relief is only available up to the amount of my income that is taxable at 40%. So lets say the amount of my income that is taxable at 40% is £5K.

Lets say I have already paid £2K into my pension and after 20% tax relief this is £2.5K. I will claim an extra £833.33 tax relief. Is that bit right?

How much of a lump sum should I pay into my pension to maximise the 40% relief? Is it £3K?

Thanks in advance

jem16

Wilma33 wrote: »

How much of a lump sum should I pay into my pension to maximise the 40% relief? Is it £3K?

Thanks in advance

It's the gross payment that counts. As you already have paid £2.5k you should pay a further £2.5k.

Wilma33

jem16 wrote: »

It's the gross payment that counts. As you already have paid £2.5k you should pay a further £2.5k.

Thanks. So should I pay in £2K so it gets grossed up to £2.5k?

jamesd

[STRIKE]£2.5k gross is £1.5k net for a higher rate tax payer. £375[/STRIKE] of basic rate tax relief will be added and the remainder declared via a letter to HMRC or tax return, so HMRC knows that they have money to pay to you. They would probably do that by adjusting your tax code.

jem16

Wilma33 wrote: »

Thanks. So should I pay in £2K so it gets grossed up to £2.5k?

Yes you should.

jamesd wrote: »

£2.5k gross is £1.5k net for a higher rate tax payer. £375 of basic rate tax relief will be added and the remainder declared via a letter to HMRC or tax return, so HMRC knows that they have money to pay to you. They would probably do that by adjusting your tax code.

Paying in £1500 would only see £1875 added to the pension which would not be enough to reduce the higher tax liability.

£2k paid in would see the pension grossed up to £2.5k and a further £500 would be claimed via the tax return or adjustment to tax code.

Wilma33

jamesd wrote: »

£2.5k gross is £1.5k net for a higher rate tax payer. £375 of basic rate tax relief will be added and the remainder declared via a letter to HMRC or tax return, so HMRC knows that they have money to pay to you. They would probably do that by adjusting your tax code.

Thanks. So in the situation I descibed in the OP, what lump sum do you think I should pay in?

CLAPTON

jem16 has already given you the correct situation

if in this tax year you earn 48,785 then you need to reduce your gross income by 5k to avoid 40% tax

as you are paying your pension from taxed income you need to make actual payment of 4,000
this will be grossed by your pension provider to 4000/.8 i.e 5,000 i.e. you have benefited by the 20% band tax

you will reclaim the the other 20% from the inland revenue by asking for £1,000 (i.e. 20% of 5,000)

so the net cost to your of 5k pension addition is 3,000 as you would expect

as you have already contributed 2,000 then you need to contribute another 2,000

just as Jem16 says

Wilma33

Thanks guys, you are great

Now for the bigger question; is this a good idea? I am young and so I am likely to take out a mortgage later in my life. So I will probably borrow more on a mortgage if I pay this money into my pension now. :cool:

Are there any other ways that I can avoid paying 40% tax (legally obviously!)? I know about gift aid. I don't have children so I'm not interested in childcare vouchers.

Btw, are the figures in this article correct?
http://www.ft.com/cms/s/2/06fcc62a-308b-11e0-9de3-00144feabdc0.html#axzz1D7yaS2V1

Wilma33

Sorry, another quick question...

If I wanted someone to look at my personal circumstances and see if this was a good idea for me, would I be better going to a tax accountant or an IFA?

CLAPTON

tax isn't the real issue here

if all depends upon your age
your actual salary
your current pension situation
your savings
your ambitions for buying a property
likely cost of a property
rich parents?

property.advert

As stated, a load of factors weigh in on this decision.

If you have to borrow more on a mortgage because you are paying into a pension then I understand your concern but you will have already benefited by 40% tax rebate on your contribution. At the moment, you would also hope that your pension increases at a higher percentage than you are paying on your mortgage. However, there are some things to remember.

If you put money into a pension which pushed your LTV over a threshold which saw massive jumps in the interest rate being charged, then as that would be charged on the whole amount borrowed, it could easily work against you.

Say you are borrowing 60k on a 100k property. You should get near the best rates at 60% LTV. But if you have to borrow 85% or £85k, then you are going to have to pay more on the whole 85k and not just on the extra 25k (85k-60k). At 2.5% for 60% and 5% for 85% then your extra interest burden is 85k*5% = 4250 - 60k*2.5% = 1500 or a net 2750. That 2750 is the cost of borrowing the extra 25k and you would need your investment of that 25k to realise a gain of 2750/25000 = 11% which is unlikely. This would continue going forward until you remortgaged.

This example is highly skewed to dramatise the point but you can plug in more accurate figures. The point is to remember that the original 60k, which you have to borrow anyway in each scenario, costs more in the second example if you cross the interest rate tier LTV.