minimising 40% tax liability by pension contribution

FatherAbraham

atush wrote: »

2% on top for those in the HRT band. So 42% tax saved?

32% tax saved on BR income below that. So fill your boots with the last 3 years excess allowance I say!

It's not higher-rate or basic-rate tax saved. You're exaggerating the benefits.

Income-taxation on pensioncontributions is deferred until income is taken from the scheme (following taking the up-tp-25% commencement lump sum).

So in retirement one might pay 0% tax on a quarter of the pot, then 0% tax on the litte bit between the state pension and the personal allowance, then 20% tax on the next bit to the higher-rate band, then 40%.

To put it another way, the tax rates on the pension income can be thought of as 0%, 15% and 30%.

For most cases, the tax saving is a long way short of 40%. (I'm ignoring the National-Insurance saving for salary sacrifice, which, in fact, is the weirdest avoidance loophole there is -- effectively the way that one pays into the pension has a huge effect on the levy one pays --this whole area seems to me to be a far more sensible one for tax reformers to consider than "removing higher-rate tax relief", because it's utterly arbitrary).

Warmest regards.
FA

zagfles

FatherAbraham wrote: »

It's not higher-rate or basic-rate tax saved. You're exaggerating the benefits.

Income-taxation on pensioncontributions is deferred until income is taken from the scheme (following taking the up-tp-25% commencement lump sum).

So in retirement one might pay 0% tax on a quarter of the pot, then 0% tax on the litte bit between the state pension and the personal allowance, then 20% tax on the next bit to the higher-rate band, then 40%.

To put it another way, the tax rates on the pension income can be thought of as 0%, 15% and 30%.

For most cases, the tax saving is a long way short of 40%. (I'm ignoring the National-Insurance saving for salary sacrifice, which, in fact, is the weirdest avoidance loophole there is -- effectively the way that one pays into the pension has a huge effect on the levy one pays --this whole area seems to me to be a far more sensible one for tax reformers to consider than "removing higher-rate tax relief", because it's utterly arbitrary).

Warmest regards.
FA

Yes, in fact the govt provide more in total relief to a basic rate taxpayer using salary sacrifice than a higher rate taxpayer using a personal pension!

They could of course do both - thinking about how this might work, say a flat 30% tax relief on contributions. They could mandate that all employer pension contributions go via payroll and are subject to tax and NI, then a 30% separate tax credit is given to all pension contributions. P60/taxable to date would show full salary including all pension contributions (employer plus employee). Tax would be normal tax applied to P60 income minus a 30% tax credit for all pension contributions. When valuing deemed employer contributions to DB schemes there would have to be some smoothing effect to avoid spikes in tax on a pay rise.

Personal pensions simply reclaim 30% tax relief - and there's nothing else to do (no need to mention on tax return etc).

They could raise the 40% threshold and lower employer NI a bit to mitigate the effect on employers who will now get charged NI on pension conts and on people who are currently basic rate taxpayers but who'd be HRT payers if their pension conts are counted.

In this scenario 30% could be fiscally neutral, or maybe even more.

Spidernick

Interesting thoughts here in the last few posts.

Personally for those who might not be drawing their pension for twenty, thirty, forty years or more, I wouldn't worry about what the tax rates would be at that stage. I agree that the eventual tax savings won't be as high as the immediate savings, but if you can get good tax relief now it's still worth doing.

The calculations above also do not seem to take account of any employer contributions to boost the pension, or growth in the pension pot (neither of which you'd have with no pension payments). If you factor these in then the tax you are paying on the amount you have personally paid over drops considerably, unless I am missing something obvious?

zagfles

Spidernick wrote: »

Interesting thoughts here in the last few posts.

Personally for those who might not be drawing their pension for twenty, thirty, forty years or more, I wouldn't worry about what the tax rates would be at that stage. I agree that the eventual tax savings won't be as high as the immediate savings, but if you can get good tax relief now it's still worth doing.

The calculations above also do not seem to take account of any employer contributions to boost the pension, or growth in the pension pot (neither of which you'd have with no pension payments). If you factor these in then the tax you are paying on the amount you have personally paid over drops considerably, unless I am missing something obvious?

Employer contribution into pension schemes has exactly the same tax treatment as employee contributions into pension schemes. The difference is in the NI treatment.

Taxation of investment growth in pensions is exactly the same as taxation of investment growth in an ISA.

Spidernick

zagfles wrote: »

Employer contribution into pension schemes has exactly the same tax treatment as employee contributions into pension schemes. The difference is in the NI treatment.

Yes, but what I'm saying is that you cannot ignore the employer pension contributions when making your comparison when taking out the pension. Part of the tax you will be paying (possibly quite a considerable part) will be based on money you haven't physically paid yourself. As such, I don't think you can look purely in terms of x% relief going in vs. y% tax paid coming out. There is more to it than that when considering the overall benefits of pension contributions.

I would agree with you if it's a personal pension with only tax relief to account for. Even then, growth in a pension is most likely to exceed growth elsewhere, other than ISAs (see below).

zagfles wrote: »

Taxation of investment growth in pensions is exactly the same as taxation of investment growth in an ISA.

Not exactly. Although there is no taxation all the while both are growing there is no tax when you take out the ISA (i.e. you get the tax relief coming out) but there is of course with the pension (i.e. tax relief going in).

I imagine that there are scenarios in which it would be overall more tax efficient to invest in ISAs than pensions (possibly for those with just a personal pension and then most likely where they will be basic-rate taxpayers when working and when they retire - if you can drop a tax band when retiring then that works in the favour of pensions), but it would require looking into a crystal ball around how the markets will fare. If an employer adds to an individual's pension contributions and/or there is also the NI relief, then pensions will normally win hands down if you don't mind your money being tied up long term.

zagfles

Spidernick wrote: »

Yes, but what I'm saying is that you cannot ignore the employer pension contributions when making your comparison when taking out the pension. Part of the tax you will be paying (possibly quite a considerable part) will be based on money you haven't physically paid yourself. As such, I don't think you can look purely in terms of x% relief going in vs. y% tax paid coming out. There is more to it than that when considering the overall benefits of pension contributions.

I would agree with you if it's a personal pension with only tax relief to account for. Even then, growth in a pension is most likely to exceed growth elsewhere, other than ISAs (see below).

The point is that as far as tax goes, it makes absolutely no difference whether your employer pays eg £2000 into your pay and you pay that £2000 into a pension, or your employer pays that £2000 direct into your pension. The tax treatment is identical. NI isn't.

Not exactly. Although there is no taxation all the while both are growing there is no tax when you take out the ISA (i.e. you get the tax relief coming out) but there is of course with the pension (i.e. tax relief going in).

Yes, exactly. The tax advantage of pensions comes only from the fact that most people will get lower tax rates taking money out than the relief they got putting money in, including eg the PCLS, using the personal allowance, getting 40% relief but paying 20% tax, plus saving NI if using salary sacrifice. The investment growth treatment is identical in a pension as an ISA.

I imagine that there are scenarios in which it would be overall more tax efficient to invest in ISAs than pensions (possibly for those with just a personal pension and then most likely where they will be basic-rate taxpayers when working and when they retire - if you can drop a tax band when retiring then that works in the favour of pensions), but it would require looking into a crystal ball around how the markets will fare. If an employer adds to an individual's pension contributions and/or there is also the NI relief, then pensions will normally win hands down if you don't mind your money being tied up long term.

If tax relief putting money into a pension was always the same as tax paid taking money out (and no PCLS) then pensions and ISAs would have exactly the same tax efficiency. The advantage of pensions comes from the fact that the average % relief when putting money is usually greater than average % tax paid taking money out.

Even if you're a basic rate taxpayer now and expect to have to pay basic rate tax on all your pension income, you'd still be better off with a pension due to the PCLS. Assuming it remains tax free, and the basic rate doesn't increase!

Spidernick

I think we'll have to agree to differ, as we obviously come at this from different standpoints. Although the tax treatment is the same re Ee & Er contributions, the fact that you are getting money paid that you wouldn't have had you not taken out the pension, must surely be a consideration when looking at the net benefit?

The point I was making about an ISA is that should the market perform better than expected, you might want to have an ISA rather than a pension, as the ISA won't be taxed coming out, whereas the pension will be, so a large gain thus avoids tax with the ISA. I very much doubt an ISA would be better overall from a tax perspective, but the new £15,000 ISA limit will be sufficient for most people, who might like the flexibility it brings.

Personally I'd put into both ISAs and pensions.

zagfles

Spidernick wrote: »

I think we'll have to agree to differ, as we obviously come at this from different standpoints. Although the tax treatment is the same re Ee & Er contributions, the fact that you are getting money paid that you wouldn't have had you not taken out the pension, must surely be a consideration when looking at the net benefit?

Yes, clearly if the employer offers a choice of pension to which they contribute, or nothing if you choose not to take the pension, then it's a case of higher overall remuneration if you choose to take the pension, so clearly it's better.

My point was that if it's a choice of a salary sacrifice type scheme, eg where salary is reduced and employer pension contributions are increased by the same amount, then the tax treatment is identical to the employee making personal or AVC contributions. NI is different.

The point I was making about an ISA is that should the market perform better than expected, you might want to have an ISA rather than a pension, as the ISA won't be taxed coming out, whereas the pension will be, so a large gain thus avoids tax with the ISA.

I guess this might be true in the rare circumstance where the investment has grown so much that it pushes you unexpectedly into a higher tax band in retirement. An ISA can only be more tax efficent than a pension if the tax rates are higher taking money out than the relief putting money in.

I very much doubt an ISA would be better overall from a tax perspective, but the new £15,000 ISA limit will be sufficient for most people, who might like the flexibility it brings.

Personally I'd put into both ISAs and pensions.

Well with the post April 2015 rules, I think the only advantage of ISAs over pensions will be the ability to get hold of the money before age 55.

nearlyrich

Spidernick wrote: »

Personally I'd put into both ISAs and pensions.

That is what I am doing but once the 15k is used up going for upping the pension contribution seems sensible in view of the fact that I am not locking it away for years as I am already 53(and two months). I do plan to step away from corporate life at 55 and whilst I understand I would need to pay tax on anything over my tax allowance (around £10k once the car, the fuel and medical benefits are gone) I can take the 25% lump sum and buy a decent but not crazy car and probably live on that for a couple of years or more as I don't have an expensive lifestyle (except I like to travel).

robin61

Spidernick wrote: »

Interesting thoughts here in the last few posts.

Personally for those who might not be drawing their pension for twenty, thirty, forty years or more, I wouldn't worry about what the tax rates would be at that stage. I agree that the eventual tax savings won't be as high as the immediate savings, but if you can get good tax relief now it's still worth doing.[/QUOTE

Yes you have to think that sooner or later someone will not be able to resist the temptation to make the tax relief less generous.

At the moment I am paying into my employer's smart AVC which is linked to my DB scheme and am getting 40% tax relief and I think 12% NI relief so it looks as if they are passing some of their savings onto me ? That sort of risk free growth on my investment would not be possible any other way. Especially as I will be able to get all of it out as a tax free lump sum without reducing my pension as long as I don't exceed 25% of the total pot. But even then I can transfer the risidual into a SIPP and only pay 20% tax when I drawdown the money. I hear what people say about investing in ISA as well but I am finding these terms are too attractive to ignore so I am making the most of it while I can.
I am hoping to take early retirement in 3 years if i can get an early leaver package (hopefully) so I have my fingers crossed that the current tax relief system will last that long or at least close to it. From what I have been reading on here it seems to me that there would need to be a consultation process of some sort and then the changes would need some time to implement. So here's hoping. Certainly if it changes before then it may compromise my early retirement plans.