Pension Contribution or Offsett Mortgage Repayment?

jamesd

1. You would have to check the rules but it is normal for salary sacrifice schemes to track and use the "scheme salary" which is the salary before any salary sacrifice. It'd be surprising if yours was any different.

2. It is not quite clear what you mean by "salary deduction". It could be "salary sacrifice" which is a reduction in gross pay with the employer instead paying more into the pension or it could be a deduction from after income tax and NI pay. The rest assumes it's salary sacrifice, deduction before tax and NI, not after. If it's after the previous calculations apply.

a. If a pension contribution is done by salary sacrifice HMRC adds nothing and the pension provider adds nothing because the salary sacrifice is done before HMRC's income tax and NI cut is taken out. So you get it automatically and in the example above in salary sacrifice you'd pay in £40,000 gross by salary sacrifice instead of £32,000 into a personal pension.
b. If your employer is sharing some of their saved employer NI it seems most common to add that to the amount going into the pension.
c. Nothing more to add for your own NI, you're just not charged it.
d. Even more attractive because of the NI gain.

3. No need to contact HMRC initially, first find out what the pension rules are.

madeinireland_2

When taking part in this sort of arrangement - can you only do it from earned income and when you are working ?

I know there are recycling issues related to the tax free lump sum - but can you do it with funds built up over a number of years from earned income or income earned from shares etc ?

If I leave work can I still put in money from savings so long as I can prove its not from the tax free lump sum ?

Thanks

madeinireland_2

Also I can understand how I could utilise this towards the end of a tax year if it was limited to earned income in that year but does this mean I can't use the option in April or May when the earned income is at that stage quite low ? If I can still plough ahead in anticipation of further earnings then what happens if I then leave work ?

Ruthy1604

jamesd wrote: »

So far as efficiency goes, forget clearing the mortgage. It's wasteful and you'd do better by using the money for pension contributions. That is one of the most efficient ways there is to use your money, including the money in the mortgage offset account.

At age 58 you're over 55 so you can get a 25% tax free lump sum from personal pensions at any time. You can then take pension income via capped income drawdown and recycle it into more pension contributions, to build up another tax free lump sum. Or to get out the rest of your net cost. It's quite an efficient way to save tax, getting the tax freed money out in the form of the lump sum.

Here's how the numbers work out for various tax rates:

tax	pay in	basic rate	tax	25% lump net	balance		income	after   years to get
		relief added	refund	sum	cost	in pension	at 6%	tax	rest out
45% 	8000	10000		2500	2500	3000	7500		450	247.5	12.12
40% 	8000	10000		2000	2500	3500	7500		450	270	12.96
20% 	8000	10000		0	2500	5500	7500		450	360	15.28

The net cost column is the net cost of the £7,500 that's left in the pension pot, after deducting the tax refund and lump sum from the initial amount paid in. Years to get the rest out is how long it takes to get the rest of that out after allowing for income tax. After that many years you're in pure profit for the rest of your life, with no remaining net cost to you. This years to get the rest out calculation uses the same tax rate as when putting the money in, in practice you might well be basic rate so the net will be higher and the number of years lower.

So if you want to do some mortgage clearing, run the money through a pension first, then do the clearing with the tax free lump sum. Though you'd do even better to recycle the lump sum into more pension contributions and gain another 25% tax free lump sum, adding that to the one you accumulate by recycling the pension income into pension contributions. There are potential limits on recycling of pension lump sums, ask for details if doing that interest you. There are no limits on recycling income, other than the annual pension contribution limit.

If you will have guaranteed income from work defined benefit pensions, the state pensions and annuities that totals £20,000 or more you can switch from the usual Capped Drawdown to Flexible Drawdown for personal pension pots. Flexible Drawdown lets you take out as much as you like from the pension pot. After the 25% tax free lump sum, the rest is taxed as normal taxable income in the years in which you take it. You can't make or have made for you any pension contributions after you start Flexible Drawdown, so don't do it until you're ready to accept that - which means not until you actually retire. Use Capped Drawdown until then.

So, your most tax efficient method using pensions is to pay in as much as is not already used of your taxable income each year until you've used the whole amount available. Use Capped Drawdown whenever the costs make that sensible, which depends on how much you pay in, probably every year or three, then recycle the income and lump sum. Do any mortgage clearing later, using the ongoing income from the pensions after you've retired when the tax rate is probably going to be lower for you.

Hi.
That's a really comprehensive reply and something I had never considered. We are pretty much fully offset.

Can I ask how you get the refund from the tax office please? DH is a 40% tax payer due to rental income etc but his pension comes out of his salary

Ruth

jamesd

Phone or a letter.

But first, is his work using a salary sacrifice scheme or not? Salary sacrifice deducts from gross pay before income tax and NI and means no claiming is needed because he'd already get full tax relief automatically due to the lower pay.

Payroll deduction can also be after tax, so NI and income tax taken off first, then the money paid into the pension with 25% added to give basic rate's 20% tax relief. In this case a phone call or letter to HMRC telling them both the net and the amount that arrives in the pension is the way to go.

Ruthy1604

jamesd wrote: »

Phone or a letter.

But first, is his work using a salary sacrifice scheme or not? Salary sacrifice deducts from gross pay before income tax and NI and means no claiming is needed because he'd already get full tax relief automatically due to the lower pay.

Payroll deduction can also be after tax, so NI and income tax taken off first, then the money paid into the pension with 25% added to give basic rate's 20% tax relief. In this case a phone call or letter to HMRC telling them both the net and the amount that arrives in the pension is the way to go.

Thanks so much
DH's is deducted net and then topped up by the pension co by 20% (not salary sacrifice).
Mine is done by deducting the contribution before calculaing tax so the tax relief is at source. Again not by salary sacrifice.
I will get the figures together and write a letter

jamesd

If you tell them what you expect will be paid in next year they may be able to adjust the notice of coding to give tax relief during the year. "May" is just because there are limits on just how much relief they can give that way. Just ask if that's what you prefer instead of a lump sum after the end of the year. Getting it as you pay in is sooner so probably better.

For any this tax year, include the bank account details for any refund to be paid into and tell them you prefer that for the current year part, if you do. Or it can be done by tax code as well.

Linton

madeinireland wrote: »

When taking part in this sort of arrangement - can you only do it from earned income and when you are working ?

I know there are recycling issues related to the tax free lump sum - but can you do it with funds built up over a number of years from earned income or income earned from shares etc ?

If I leave work can I still put in money from savings so long as I can prove its not from the tax free lump sum ?

Thanks

It only works when you have sufficient taxed earned income to cover your pension contributions and your total annual pension contribution is less than £50K. You dont get tax relief on pension contributions from unearned income or contributions beyond £50K, but you do get taxed when anything beyond the 25% tax free lump sum is withdrawn - a bad combination!

There is one small exception - if you are not a tax payer then you can contribute £2880 and you get a rebate of nonexistant tax to raise the amount to £3600. The problem with doing what Jamesd suggests with very small pensions is that the charges for taking drawdown become relatively significant.

Linton

madeinireland wrote: »

Also I can understand how I could utilise this towards the end of a tax year if it was limited to earned income in that year but does this mean I can't use the option in April or May when the earned income is at that stage quite low ? If I can still plough ahead in anticipation of further earnings then what happens if I then leave work ?

The only thing that matters is the overall situation at the end of the tax year. So provided your pension contributions havent exceeded your taxed earned income in the tax year you retire you are OK. It doesnt matter when in the tax year the contributions were made.

jamesd

madeinireland wrote: »

When taking part in this sort of arrangement - can you only do it from earned income and when you are working ?

No. There are two different sets of limits that apply:

1. The amount of earned income in the tax year. If no earned income, £3600 gross, £2880 net and you get basic rate relief on this.
2. The annual pension contribution allowance, currently £50,000, dropping to £40,000 from 2014/5 tax year. You can carry forward unused allowance from the previous three years if you were in a pension scheme in the year you're carrying forward.

madeinireland wrote: »

I know there are recycling issues related to the tax free lump sum - but can you do it with funds built up over a number of years from earned income or income earned from shares etc ?

Yes. See the examples linked from there to get an idea of how it works. Note that there's no restriction if the amount of the lump sums taken at the time and in the previous 12 months is no more than 1% of the lifetime allowance, which is currently £1.5 million but is dropping to £1.25 million from 6 April 2014. You don't have to take all of the lump sum from personal pensions at the same time, you can do it in stages if you like, taking the whole 25% lump sum from part at one time, then doing more later. Or you can use the increased contributions by more than 30% of the lump sum rule to be sure you don't exceed it. HMRC has to prove it was done with prior planning as well, so that protects people, though HMRC may use facts to claim it was preplanned even when it wasn't.