Contributing 100% of gross salary

Judwin

Hi, I've been trying to work out in my head a couple of stratergies for the final few years before my 55th birthday when I could commence my personal pension. I know everyone can contribute £3600 gross (£2880 net) regardless of how much you earn. Bit You appear to be able to contribute 100% of your Gross salary too.

So, two scenarios...

Scenario 1:
You have large SS ISA savings, and you currently earn £8105 gross. All other things being equal, your tax code is 810, so you pay no tax to HMRC. You cash in some of your SS ISA, write out a cheque for £6485, and send it off to your PP provider. They then gross it up to £8105. You have 'reclaimed' £1621 of tax that you never paid?

Scenario 2.
You have large SS ISA savings, and you currently earn £40K gross. All other things being equal, your tax code is 810, so you pay 20% tax on £31895 (£40K - £8105) HMRC. You cash in some of your SS ISA, write out a cheque for £32K, and send it off to your PP provider. They then gross it up to £40K. You have 'reclaimed' £8000 of tax, but only paid £6379?

I'm struggling to see where the flaw in this stratergy is. Same investment options available in both SSISA and PP/SIPP, so future growth will be similar. You can get 25% of your lump sums back as TFC if desired. If the SSISA is supposed to boost your income in retirement, then it gets a 25% uplift by simply putting it in a PP/SIPP.

It seems to me that it may be worth contributing 100% of "salary" into a PP for the last several years before retirement providing you've got the "cash" saved away in other investments.

What have I overlooked? - Can you really reclaim tax that you never paid?

Cheers
Judwin

mania112

Unless i'm missing something, you're counting investment returns as salary?

Old_Slaphead

You get tax relief on contributions of up to your net relevant earning (not investment income) or £3600 whichever is more.

BUT you have to pay tax (assuming you have sufficient income) on any income received from your PP plans - unlike with your SSISA

Judwin

mania112 wrote: »

Unless i'm missing something, you're counting investment returns as salary?

No. Scenario 1 might apply for someone with a low paid job, but with SSISA (or even cash ISA) of a few tens of thousand. Or perhaps the wife of a (small)company director .

And Scenario 2 might apply to someone with a 40K salaray, but with significant SSISA of many 10's of K.

jamesmorgan

It is best to think of pension money as subject to deferred tax. Most money paid out of a personal pension is subject to standard rate tax (especially after taking the state pension which uses up most of the tax free allowance). It is possible that some money paid into the pension will get tax relief even though the earnings will not have been taxed, however, it is also possible that this money will be taxed at standard rate when taken as a pension (ie is tax neutral).

The most likely exception to this is a personal pension taken before standard retirement age when the pension is below the tax free threshold. This is often the case for a spouse's pension who has not worked most of their working life. This is the approach we have been taking with my wife -almost all of her recent earnings are going into a pension which will be taken when she is 55. The net result of this is that she will effectively pay no tax on those earnings. She also benefits by maximising CTC/WTC payments.

Judwin

Old_Slaphead wrote: »

You get tax relief on contributions of up to your net relevant earning (not investment income) or £3600 whichever is more.

yes - but you dont pay tax on the first £8105 of net relavent earnings, so assuming your gross salary is at least £8105, then the PP can reclaim £1621 of tax that you never paid?

Old_Slaphead wrote: »

BUT you have to pay tax (assuming you have sufficient income) on any income received from your PP plans - unlike with your SSISA

Except you can take 25% out tax free, and you can take out £8105 per year tax free too. The state pension won't kick in till you're 67/68 so the marginal tax rate is much beter than it would be for an SSISA.

Linton

I think you are correct but over-complicating the point which is basically the advantage of the 25% tax free lump sum.

Assuming no investment return:

Look at it this way: consider the rebate you get to be against the tax when you withdraw the pension, not against the tax on your wages. And assume that your tax free allowance after retirement is taken up elsewhere. Then without the TFLS the tax you pay on the pension would match the rebate you got so you would be no better off circulating the money via the pension. But you do get the TFLS so are better off.

So some real numbers, assuming 8K allowance

£40K Wages

---

> £6400 Tax

---

> £33600 In Hand


£40K in Pension <

---

£32K contribution

"""""""""""""""""""""

---

>£6000 Tax

---

>£34K In hand

So you are left with £35600 In Hand, a profit of £2K which is the tax on the TFLS.

Judwin

jamesmorgan wrote: »

It is best to think of pension money as subject to deferred tax.

Perhaps, but if you take the 25% TFC then it's better described as deferred income taxed at three quarters of your normal rate.

jamesmorgan wrote: »

Most money paid out of a personal pension is subject to standard rate tax (especially after taking the state pension which uses up most of the tax free allowance).

Not if you intend/hope to retire at 55. You've got at least 12 years of income before the state pension kicks in. And when it does kick in, assuming you're on drawdoiwn, you just reduce the amount you're drawing down.

Judwin

Linton wrote: »

I think you are correct but over-complicating the point which is basically the advantage of the 25% tax free lump sum.

yep understand all that, but disagree with...

Linton wrote: »

And assume that your tax free allowance after retirement is taken up elsewhere. Then without the TFLS the tax you pay on the pension would match the rebate you got so you would be no better off.

At age 54 years and 364 days, you pay in 100% of this years salary, by transferring the money from SSISA to PP. At age 55 years and 0 days, you commence the pension.

You don't get state pension for another 12/13 years, so what is it that is taking up your tax free allowance?

Old_Slaphead

Judwin wrote: »

Perhaps, but if you take the 25% TFC then it's better described as deferred income taxed at three quarters of your normal rate.



Not if you intend/hope to retire at 55. You've got at least 12 years of income before the state pension kicks in. And when it does kick in, assuming you're on drawdoiwn, you just reduce the amount you're drawing down.

No different in principle from immediate vesting by someone with no income except you've a bit more NRE/contribution to play with.

Anyone can contribute to pension £3600pa (£2880 net) and get £900 TFC.
Pension fund worth £2700 for net cost of £1980.

A bit out of date but theory is discussed here

http://www.telegraph.co.uk/finance/personalfinance/pensions/4228907/How-pensioners-can-get-a-guaranteed-return-of-12pc.html#

jamesmorgan

Judwin wrote: »

Not if you intend/hope to retire at 55. You've got at least 12 years of income before the state pension kicks in. And when it does kick in, assuming you're on drawdoiwn, you just reduce the amount you're drawing down.

Yes, as explained in my reply the scheme is attractive to someone who doesn't have much pension rights built up. A pension pot of around £160K will pay an annuity of £8K at age 55. Once you have over £160K in the pot it becomes less attractive as every extra £ put in is likely to be subject to standard rate tax. The TFLS does partially offset this, but this is compensation for tying your money up in the restrictions associated with a pension.