Pension planning and removal of lower rate tax band

Paul_Herring

What changes need to be made to planning now that the 10% tax band has been removed? From http://news.bbc.co.uk/1/hi/business/6474079.stm :

BBC wrote:

The big news is that the basic rate of income tax has been cut by 2p to 20p.

At the same time, the 10p income tax rate on the first £2,090 earned above your personal allowance is being abolished.

This means in effect that you will have to pay 20% as soon as you earn more than your personal allowance rate.

(emphasis mine)

Now I've seen numerous posts on here (usually in the Pension vs ISA questions) in the past indicating that you should make provision for a pension income of around £10K which uses up the 0% and 10% bands, and put other contributions elsewhere. The abolition of the 10% rate reduces this by ~£2K - should the calculations be changed from £10K to £7.5K (the personal allowance for 65-74 2007/2008)?

In the same article:

BBC wrote:

For those [pensioners] under the age of 75 the tax free allowance will rise in stages from £7,280 to £9,770 in 2011. This may offset the extra cost due to the abolition of the 10% income tax rate.

Still seems the government is getting more tax than they would if they immediately upped the 65-74 allowance amount to the current 0%+10%. I'm sure that £9,770 in 2011 won't be worth as much as £9,780 is/will be in 2007/2008.

This question is not intended to start another rehash of Wrapper A vs Wrapper B for pensions, but purely on the £10K figure used in previous discussions.

dunstonh

As the personal allowances are going to be upto the same level of the current nil rate and 10% band for over 65s within 3 tax years, I would still plan for 10k using pensions.

jamesd

Assuming 3% inflation for 5 years that 9780 is equivalent to 8436 today. Subtract the current 7280 and the increase is 1156 with no tax.

For someone with a taxable income of 7280(nil)+2150(10%)=9430 Their tax is 10% of 2150 = 215 today. After the change it's 9430-8436=994 taxable at 20%, tax of 199. So, better off by about 20.

Add 100 more income and the tax on 9530 becomes the same as it is today. Above that the person is a bit worse off.

It's even more important in the future to evenly split taxable income between a couple because not splitting costs 20% instead of 10% on the first 2150 of the income over one person's allowance, while the combined no tax allowance rose from 14560 to 16872.

All numbers are approximate, just to give a general idea of the effects.

exil

It doesn't seem to me to be very wise to plan on the basis of what this or a future Chancellor is going to do in this much detail at least. All we can say is that the tax regime in future is likely to be similar to today's.

EdInvestor

How is age allowance clawback affected, anyone know?

dunstonh

I havent seen anything on that front yet but the increases would suggest that planning your income if you are going to be close to that age allowance reduction figure is going to be more important now as the amount that can get clawed back is going to be bigger.

EdInvestor

Seems to me the new large age allowance (10k by 2011) could indeed alter the landscape quite significantly.

You're going to end up with 4 separate tranches of taxable income:

Tranche 1 (> 10k) tax free

- Includes state pensions, likely to mean it will be worth everyone's while to acquire an additional pension pot of up to c.100k

Tranche 2 (10k to c.22.5k) taxed at 20%

Worth it for a BRT with employer's cont and an HRT to acquire additional pension saving of between 200k and 350k.

Tranche 3 (22.5k-32.5k) punitively taxed via age allowance clawback of 30%(?)

Not worth accumulating pension earnings above 350k, unless the final total is sure to be enough to put you into tranche 4, ie over 550k

Tranche 4 (32.5 - 42.5K) taxed at 20%

On pension pots of 550k-750k

Tranche 5 (42k+) taxed at 40%.

On pension pots of 750k+

*Add 25% to these pot sizes to take account of TFC.

Looks to me that pension saving for many will be capped at around the 450k (incl TFC) lifetime level, with savings/investments in excess of that better placed in ISAs.

The overall structure looks a lot more logical than in the past.Perhaps it will also reduce demand for upfront tax relief for pension pots over 450k? If an effective cap does appear, that might allow the Government to be more liberal in due course on annuities and ASP rules for the over 75s.

At the other end it does also offer a clear incentive for people to save, rather than rely on benefits.The savings landscape looks much tidier with around 10k of clearly tax free savings available p.a.

3600 cash ISA (300 a month)
3600 investment ISA ( 300 a month)
3600 stakeholder pension (you pay 2880 - 240 a month)

The small stakeholder or NPSS pension as an add-on to state entitlement with tax relief upfront, no tax on income and 25% tax free cash lump sum now looks a much better deal.IVPs should do well going forward, and the NPSS also looks more viable.

The better off have a slightly increased maxi ISA of 7200, plus at least 15k a year of NS&I tax free index linkers ( some of which might be converted later on into an IVP to use up the spouse's allowances.)

jamesd

EdInvestor, following the pattern of the change in NI it might end up being one pound in every five with full clawback being reached at the start of the upper tax band and the starting point set to whatever is necessary to make the one in five work out nicely, around 20,000 still. The disadvantage of this is that it would reduce income for the Treasury so it might be made 1 in 6 or 1 in 7 or even 1 in 8 to lower the starting point to 18600, 14700 or 10800.

Marginal rates of 24% (1 in 5), 23.3% (1 in 6), 22.9% (1 in 7) or 22.5% (1 in 8) compared to a basic 20% rate look as though they might significantly reduce the benefit of avoiding pension use and that's also likely to be seen as a desirable policy result. Looks like it could be seen by a macro-economist as an attractive pension simplification.