minimising 40% tax liability by pension contribution

Spidernick

If you're paying 40% tax then your NI rate at that income will be only 2%. It all helps though.

zagfles

Spidernick wrote: »

If you're paying 40% tax then your NI rate at that income will be only 2%. It all helps though.

Usually, but not always, for instance if the PP's basic salary is in the basic rate band but they get a taxable benefit such as a company car which pushes them into the 40% tax band, they would still be paying 12% NI.

robin61

Spidernick wrote: »

If you're paying 40% tax then your NI rate at that income will be only 2%. It all helps though.

When I started paying into the smart AVC and subsequently as I have increased contributions I have noticed a significant reduction in NI. A lot more than 2% which is what I had initially expecting to receive. I think it is probably because sacrificing salary saves the employer on NI payments and I think they must be passing at least some of it on.

jamesd

You can't pay in more for the previous tax year but you may have unused annual contribution allowance that could let you pay in more than £40,000 this year. If that applies you should also check your Pension Input Period to determine which year's allowance is being used because it is possible even with no carry forward to pay £80,000 into a pension in one tax year if the PIPs aren't aligned with the tax year and you arrange to pay in within the two PIPs.

To eliminate your higher rate income tax, add up all of your work and non-work taxable income and your BIK. Deduct the higher rate threshold from that and the result is the amount you need to sacrifice to eliminate your higher rate liability.

So far as tax reliefs go, for convenience I'll assume that you have a work income of £62,000 including BIK, savings interest income of £5,000, that the higher rate threshold is £42,000 and is aligned with the change point for NI rates, as it is now. I'll also use your employer adding their full NI saving but ignore your 10% matching. Here's how your reliefs work out:

1. 55.8%: The first £20,000 it higher rate income and higher rate range NI so you get 40% income tax plus 2% employee plus 13.8% employer NI.
2. 65.8%: For the next £5,000 your workplace sacrifice is now in the basic range so you get 12% employee NI saving. But your income is still in the higher rate range so you're still saving 40% income tax. You also save the 13.8% employer NI.
3. 45.8%: Now both income tax and NI are in the basic rate range so you gain from 20% income tax, 12% employee NI and 13.8% employer NI.
4. I'll ignore sacrifice that takes you to the point where NI can drop.

Assuming you are a basic rate tax payer in retirement and that your whole personal allowance is used in other ways your gain in each scenario for £1,000 ignoring any growth would be:

1. Pay in £1,000 gross, employer adds 13.8% so pension has £1,138. Your net cost when paying in is £580. Take out 25% PCLS tax free, £284.50. Take out the remaining 75% as practical with 20% tax to pay, get out £682.80 after tax. Total after tax amount taken out is £967.30 for your £580 cost. You have 1.67 times as much money as you started with or alternatively, your net cost is 60% of what you get out.

2. Pay in £1,000 gross, employer adds 13.8% so pension has £1,138. Your net cost when paying in is £480. Take out 25% PCLS tax free, £284.50. Take out the remaining 75%, get out £682.80 after tax. Total after tax amount taken out is £967.30 for your £480 cost. You have 2.01 times as much money as you started with or alternatively, your net cost is 49.6% of what you get out.

3. Pay in £1,000 gross, employer adds 13.8% so pension has £1,138. Your net cost when paying in is £680. Take out 25% PCLS tax free, £284.50. take out £682.80 after tax. Total after tax amount taken out is £967.30 for your £680 cost. You have 1.42 times as much money as you started with or alternatively, your net cost is 70.3% of what you get out.

So your effective after tax gain on what you get out vs what you paid in from the various reliefs is 1: 40%, 2: 50.4%, 3: 29.7%.

"Net cost" as I have used it here is somewhat bogus for a person over 55 who can take out the 25% PCLS almost immediately, only having to delay to get the rest out at basic rate, assuming that the drawing limit has been removed already.

jamesd

zagfles wrote: »

say a flat 30% tax relief on contributions

Your plan is perfect except for one detail: which higher rate tax payers would bother to make any pension contributions except up to the limit of employer matching?

Pension: 30% relief once only at least until age 55.

VCT: 30% initial relief. Income is tax free. Can sell and get another 30% provided you hold for at least five years, no 55 minimum age to get money out, 100% death benefit level whether income is taken or not.

zagfles

jamesd wrote: »

Your plan

It's not "my plan", it's some thoughts about how the mooted flat rate tax relief might work in practice. Political opinion seems to be moving in that direction eg see http://www.telegraph.co.uk/finance/personalfinance/pensions/11037883/Pensions-tax-relief-will-be-cut-after-the-election-whoever-wins.html

is perfect except for one detail: which higher rate tax payers would bother to make any pension contributions except up to the limit of employer matching?

Pension: 30% relief once only at least until age 55.

VCT: 30% initial relief. Income is tax free. Can sell and get another 30% provided you hold for at least five years, no 55 minimum age to get money out, 100% death benefit level whether income is taken or not.

Plently. Getting 30% relief and paying 15% tax (assuming the HRT payer will be basic rate in retirement) is still a good deal, and lots of them won't understand or want to risk VCTs.

Plus I doubt the govt would care whether HRT payers choose to use VCTs instead of pensions for retirement saving. They're more interested in getting lower earners to use pensions, and to stop them being seen a a tax break for the "rich".

jamesd

30% relief then 15% tax isn't a bad deal but it is a much less good deal than getting 150% relief and paying no tax at all, subject to the risk profile being suitable for the amount going into the VCTs. That condition won't be met by quite a few people but it takes quite big losses to eat up such a huge difference in reliefs.

Spidernick

JamesD,

It is highly unlikely that an employer will give the employee the full 13.8% Er NI saving - I've certainly never heard of that and what would be the incentive to the employer for opting for a Smart pension scheme if they did (other than to keep the employee very happy indeed). Most give up to half from my experience and normally less than that.

The 40% tax and 12% NI is interesting when investment income is factored in (thanks to you zagfles for that). With three kids I'm currently effectively saving about 66.75% with the bulk of my pension payments (40% tax, 2% NI and around 24.75% with child benefit not then clawed back). Someone with the same number of kids qualifying for child benefit, the same income level as me, but with a lot of it in say rental income could increase the Ee NI saving by another 10%, giving a total of 76.75%. Then add the 13.8% Er NI the government isn't getting then that's 90.55% - it really couldn't happen to a nicer government if that could be achieved (and I'll settle for my 80.55% for now which has rather made my day!).

jamesd

Spidernick wrote: »

It is highly unlikely that an employer will give the employee the full 13.8% Er NI saving - I've certainly never heard of that

Just read our original poster's posts in this discussion and now you've heard of it:

nearlyrich wrote: »

I get the Employers NI credited along with their contribution...

I agree that it is relatively uncommon. The most I've received is half.

Spidernick wrote: »

what would be the incentive to the employer for opting for a Smart pension scheme if they did (other than to keep the employee very happy indeed).

What is the employer incentive to do more than the minimum required by auto-enrolment law? Yet employers do. This scheme seems better than most so it's an advantage compared to their competitors in the marketplace. Whether there is remaining employer benefit from corporation tax savings, I don't know.

I do know that for higher rate tax payers the 2% NI employee NI saving is not a great incentive to use the employer's scheme rather than another one and that there is likely to be some benefit for encouraging higher rate earners to pay into such a scheme to keep overall costs down, exploiting the greater contributions that the higher earners may make to the scheme. In some areas there is also competition for employees and a particularly generous DC scheme would be of interest to some.

Spidernick wrote: »

With three kids I'm currently effectively saving about 66.75% with the bulk of my pension payments (40% tax, 2% NI and around 24.75% with child benefit not then clawed back). Someone with the same number of kids qualifying for child benefit, the same income level as me, but with a lot of it in say rental income could increase the Ee NI saving by another 10%, giving a total of 76.75%. Then add the 13.8% Er NI the government isn't getting then that's 90.55% - it really couldn't happen to a nicer government if that could be achieved (and I'll settle for my 80.55% for now which has rather made my day!).

Sometimes pensions can be a really great deal.

In some ways I look on my pension contributions as getting me a pension with my home thrown in free. That home is going to cost me nothing because tax and NI relief and/or employer's contribution will pay for it.

Spidernick

jamesd wrote: »

Just read our original poster's posts in this discussion and now you've heard of it:
I agree that it is relatively uncommon. The most I've received is half.

I'm still not convinced. I did challenge him on this, but he hasn't replied on that specific element. My point was that the main benefit of Smart as opposed to standard employer pensions is the NI saving. I would imagine that Smart pensions cost more to administer (but may be wrong in that regard) hence my comment. An employer wouldn't be out of pocket voluntarily.