Saving tax now to pay it later

garybarlowsbeard

Disclaimer: I know next to nothing about pensions.

I'm one of two equal partners in a ltd company. We're thinking of starting paying into a pension which I believe would be best done directly from the company, thus saving the company from paying corporation tax on the contributions. However, as I understand it, should my combined state and private pension go over the income tax rate I would then have to pay income tax?

So, does it make ANY sense at all to aim to create a pension fund that will pay at the income tax threshold with the rest being saved in an ISA (that money coming from me of course, having already paid income tax on it).

Cheers
GBB

jamesd

With the pension you get the income tax and corporation tax and NI saving benefits. With the ISA you don't. When you take money out of the pension, 25% is taken out tax free. The rest is at whatever tax rate applies to each portion of the income. It's also pretty common to have a higher income tax rate while working than in retirement, further increasing the pension advantage.

What this means is that the pension normally wins and you'd probably end up better planning to take pension income from the 75% and use the lump sum to put money into the ISA.

You do need to consider the pension lifetime allowance of £1.25 million, perhaps assuming a reduction to a million. Don't want to go over that for the total pension pot size.

You can avoid some income tax if you think that VCTs are suitable for you. You'd need to be sure that they fit your risk tolerance and other circumstances, like not being a high percentage of our total investments, but they offer 30% income tax relief when purchased. Tax relief is limited to the amount of income tax actually payable in the tax year of purchase. Income is tax free and perhaps 8-9% effective can be obtained after allowing for the reduced purchase price. No CGT. Tax relief has to be repaid if you sell within five years but you should normally plan to hold for more like twice that. These can be interesting because you can run your taxable pension withdrawing money through the VCT to effectively avoid the income tax, or at least 30% of it.

garybarlowsbeard

With the company we would only get the CT saving as our pay is structured so we don't pay income tax and only minimal NI.

Wouldn't the ideal position be to have a pension pot that allowed 25% to be taken tax free and then the rest equate to earnings at the maximum income tax rate?

Cheers
GBB

jamesd

Perhaps. Depends in part on whether you're interested in making more pension contributions to get another lump sum after the first one and on whether you might be interested in using VCTs to defer the income for 5-8+ years and get 30% tax relief at the start plus tax free income, which largely depends on your risk tolerance for small businesses and how much money you have at that time. VCTs aren't suitable for most people but might be for your circumstances at some point.