Maximising 40% tax relief on pension contributions

jamesd

jem16 corrected my tax calculation, silly mistake on my part.

What I'm doing is making pension contributions so the pension will clear the mortgage and leave me with a higher pension income. Interest only mortgage. That gets me tax relief on the money used to buy the property. It's particularly useful for higher rate tax payers but can also pay very well for basic rate, particularly if salary sacrifice is used for pension contributions. The main catch is that you can't get the lump sum to clear the mortgage until you're 55.

Loughton_Monkey

If your concern is primarily making 'maximum' return on your money, then I would not imagine any better investment than dumping your 'max' amount into pension to get the 40% tax relief.

Avoiding 40% tax relief by paying the appropriate amount into pension - on the assumption that you will 'draw' your pension as a basic rate taxpayer - would generally have no rivals for 'efficiency'. No other 'investment' would reasonably be expected to return more [other than mythical scenarios like dumping it all into another 'Microsoft' of tomorrow].

However, this comes with 'consequences'. These are all the constraints (that I assume you know about) concerning the specific limited way you get your 'investment' back.

And as is quite obvious, once the money is 'in' it is unavailable for any other purpose like house deposits. So it really becomes a 'cash flow' issue and one you need to judge for yourself. Arguably, investment in property can be as 'lucrative' as pensions [in very 'round figures'] but as a general rule, you should consider that 'investment' to be even less 'liquid' than a pension - unless you plan to downsize at retirement.

Wilma33

I'm back again

When calculating the pension contributions made in a tax year, do you look at the tax year the contribution was deducted from your salary (e.g. 31/03/2010) or the date the contribution was actually invested in your pension (e.g. 20/04/2010)?

Also, I have just realised that the AMC on single contributions is higher than on regular contributions. With only one pay day until the end of the tax year, is there any way around this? I was thinking I could work out what percentage pension contribution will result in a take home pay of zero, and change my pension percentage to that for one month. Does that sound like a viable workaround?

jem16

Wilma33 wrote: »

I'm back again

When calculating the pension contributions made in a tax year, do you look at the tax year the contribution was deducted from your salary (e.g. 31/03/2010) or the date the contribution was actually invested in your pension (e.g. 20/04/2010)?

It's the date of the actual investment as that is what your pension provider will provide as proof for HMRC.

Also, I have just realised that the AMC on single contributions is higher than on regular contributions. With only one pay day until the end of the tax year, is there any way around this? I was thinking I could work out what percentage pension contribution will result in a take home pay of zero, and change my pension percentage to that for one month. Does that sound like a viable workaround?

Possible if the pension provider will allow it.

MarkPC

Sorry for late entry to this discussion but there is something I don't understand.

If pension payments are are eligible for full tax relief then in the example CLAPTON gave below the original gross amount for a net payment of £4000 by a higher rate tax payer would be:

£4000/0.6=£6666.67
making the higher rate tax paid:
£6666.67*0.4=£2666.67

The pension company would reclaim 20% tax presuming the pension holder was a lower rate tax payer. Therefore the tax reclaimed by them would be as CLAPTON showed ie:

£4000/0.8=£5000 (to get to pre tax gross amount)

So tax reclaimed:
£5000*0.2=£1000

Does this mean that the pension contributer is entitled to the difference between the higher and lower rate tax paid? ie:

£2667.67-£1000=£1667.67

rather than another 20% of the lower rate amount claim by the pension company.

Hope this makes some sense - cheers!

CLAPTON wrote: »

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

jem16

MarkPC wrote: »

Sorry for late entry to this discussion but there is something I don't understand.

If pension payments are are eligible for full tax relief then in the example CLAPTON gave below the original gross amount for a net payment of £4000 by a higher rate tax payer would be:

£4000/0.6=£6666.67
making the higher rate tax paid:
£6666.67*0.4=£2666.67

No that's not what happens. Any pension payment should be paid net of 20% basic rate tax and not higher rate tax.

So a £4000 net payment becomes a £5000 gross payment via the pension provider.

You then claim the extra 20% from HMRC so a £1000 is rebated back to you either as a cheque or an increased tax allowance.

warwicktiger

MarkPC wrote: »

Sorry for late entry to this discussion but there is something I don't understand.

If pension payments are are eligible for full tax relief then in the example CLAPTON gave below the original gross amount for a net payment of £4000 by a higher rate tax payer would be:

£4000/0.6=£6666.67
making the higher rate tax paid:
£6666.67*0.4=£2666.67

Er, no.

If the 40% liability is £5000 this is the GROSS figure required to remove it, so the total payment would be £4000 net OF BASIC RATE TAX, the additional tax relief would be given by adjustment of tax code or refund, meaning the NET outlay is £3000 overall.

Just goes to show how good this can be for those already able to draw the benfits, of the GROSS £5000 25% ie £1250 can be taken as tax free cash, meaning that the residual pot of £3750 (5000-1250) has cost only £1750 (5000 gross, less 1000 basic rate tax deducted at source, less 1000 higher rate tax relief less 1250 cash.

Anyone fancy a £3750 pension pot for £1750?

Linton

To add a bit:

If you are a private individual making your own contribution to your pension, I agree that jem16 is correct.

However if this a pension paid from your wages by your employer then in some (many?) cases, the full payment is taken from your gross pay, in this case £5K, and the appropriate tax adjustments made via PAYE.

MarkPC

Thanks for replies. The bit which got me started on this was from the HMRC website:

"You pay Income Tax on your earnings before any pension contribution, but the pension provider claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot. If you pay tax at higher rate, you can claim the difference through your tax return or by telephoning or writing to HMRC."

The ambiguous bit for me is what is meant by 'the difference'. In terms of the tax actually paid by a higher rate payer this is not another 20% of £100 using the example above. But (£80/0.6)-100.

Does anyone know if the HMRC have clarified that the maximum gross amount is limited to basic rate rax band and it is assumed threrefore that the 40% is on this smaller figure?

jem16

MarkPC wrote: »

The ambiguous bit for me is what is meant by 'the difference'. In terms of the tax actually paid by a higher rate payer this is not another 20% of £100 using the example above. But (£80/0.6)-100.

You are looking at it from the wrong angle. HMRC always look at the gross payment and tax relief is worked from that and not the net payment that you are using.

So if you want £100 paid into your pension, that is the gross amount. You pay in the net amount which is the gross minus 20% tax relief = £80. £80 is paid to the pension and the pension provider claims the 20% tax relief of £20 making it up to £100.

If a higher rate taxpayer you then tell HMRC that you have made a gross payment of £100 and they will then give you a further £20 tax relief. This is paid back to you in cash. So your £80 net has now only cost you £60.

Does anyone know if the HMRC have clarified that the maximum gross amount is limited to basic rate rax band and it is assumed threrefore that the 40% is on this smaller figure?

You will be given 40% tax relief on the gross figure once you start thinking about it correctly.