Increase pension for tax relief

AT_London

Dear MSExperts,

I have just subscribed to this wonderful forum which so far helped me to understand how to save/leverage investments/and generally manage our money using MSE techniques. So thank you already for this!

Just a quick overview on our household. My wife and I moved to London 2 years ago, we both have a relatively good paid job, no kids, no debts, and trying to save to overpay our mortgage, we have a small saving pot (£5k) for emergencies.

My current question is:
I will be starting a new job soon, and my new salary will be £45k pa. So I will be paying a higher tax rate (40%) on £3,135 per annum (£45,000 - £10,000 (personal Allowance) - £31,865 (cap for basic tax rate). However, my company will also double my pension contributions up to 5%. So I am planning to put the max of 5% of my salary before tax directly into the company pension fund, and my company will put 10%. So £2,250 per annum will be part of this salary sacrifice before tax (I'd imagine if the new pension company Friends Life has the same rules as my current pension company Fidelity).

Now, I really want to maximize my savings, and put in place the most efficient tax savings plan. So my question is: should I put the remaining £885 (£73.75 per month) pounds in the same pot (Friends Life) to avoid in a high rate tax band? Or should I open personal pension plan? Also, how much would I "save" on annual basis via this additional tax relief? What are the exact benefits? Maybe it is better to overpay my mortgage?

Another question: If at some point during the year I receive a small bonus of 2K-3k, would I be automatically returned to a higher rate payer status, or would the tax on bonus be calculated separately from the main salary?

Apologies for so many questions, but I just need some light on how to manage this as I am so close to the line between basic and higher tax rate.

Thank you in advance for your feedback,

AT

dunstonh

So my question is: should I put the remaining £885 (£73.75 per month) pounds in the same pot (Friends Life) to avoid in a high rate tax band?

That is certainly an option and which achieve that goal.

Or should I open personal pension plan? Also, how much would I "save" on annual basis via this additional tax relief?

Exactly the same as the Friends Life pension through work unless the employer offers salary sacrifice.

Maybe it is better to overpay my mortgage?

How would that help towards your retirement planning goal? (low interest rates typically lower than investment returns and no tax relief, which may not be around forever)

Another question: If at some point during the year I receive a small bonus of 2K-3k, would I be automatically returned to a higher rate payer status, or would the tax on bonus be calculated separately from the main salary?

All income and interest you earn in the year regardless of when or how it is paid in that year is totalled up and thats what you pay tax on.

Your_Hero

AT_London wrote: »

So £2,250 per annum will be part of this salary sacrifice before tax (I'd imagine if the new pension company Friends Life has the same rules as my current pension company Fidelity).

Not necessarily as salary sacrifice is done through your company's payroll and not through the pension provider.

Now, I really want to maximize my savings, and put in place the most efficient tax savings plan. So my question is: should I put the remaining £885 (£73.75 per month) pounds in the same pot (Friends Life) to avoid in a high rate tax band?

Yes.

Or should I open personal pension plan?

For £885 gross per annum it's unlikely you're going to find a more competitive plan than your employer's pension. Charges aren't the most important factor of course, and by all means, do it if you want more flexibility on investment choice etc.

Also, how much would I "save" on annual basis via this additional tax relief? What are the exact benefits? Maybe it is better to overpay my mortgage?

The benefit is you will save 40% tax on your contribution.

If it is done through salary sacrifice then, on higher rate tax you will save an additional 2% of NI on the gross amount, i.e. £885 x 2% = £17.70. The employer will also save 13.8%, which is £122.13. The more generous employers will give you some of this NI saving while others won't at all. As you can imagine, the NI savings will make a big difference over time.

Another question: If at some point during the year I receive a small bonus of 2K-3k, would I be automatically returned to a higher rate payer status, or would the tax on bonus be calculated separately from the main salary?

You will likely be taxed at the higher rate because in practice your personal allowance, and tax bands are divided in equal proportions over the 12 months of the year.

You can make further pension contributions to try and offset this and reclaim the additional relief from HMRC (phone them or write to them, no need for a full self assessment if this is all there is).

Notfarfromtheborder

With regards to your bonus, if you don't need it, ask the employer to put the gross amount into you pension via salary sacrifice, you'd get the full amount credited, if you got it paid you would lose 40%

Your_Hero

Notfarfromtheborder wrote: »

With regards to your bonus, if you don't need it, ask the employer to put the gross amount into you pension via salary sacrifice, you'd get the full amount credited, if you got it paid you would lose 40%

He/She would lose 42% (2% NI).

jamesd

How close to being 55 are you? It's hard to beat using a pension tax free lump sum to do mortgage clearing, since it in effect is coming out of the tax relief, not your own pocket.

With the new pension rules you're not restricted to taking out just 25% of the pension pot so at 55 you can take out sufficient to clear the mortgage if you have deliberately paid the "overpayment" money into the pension to allow for this without harming your retirement income plan.

For the pension money beyond the 25% you don't gain on income tax much (except due to some gross rollup effects) but when using salary sacrifice you do still gain from the NI benefits on it.

AT_London

Thank you all. it confirms my initial thoughts.

How close to being 55 are you? It's hard to beat using a pension tax free lump sum to do mortgage clearing, since it in effect is coming out of the tax relief, not your own pocket.

We are far from retirement. Actually we are closer to our thirties, just bought a flat with 80% LTV, and trying to find a balanced plan to redistribute our money: put it in the pension pot versus overpay the mortgage versus put the cash in ISA etc?

My new salary will put me just above the high tax rate, so all your comments confirmed that it is worth indeed putting this "small amount" into our pension pot as we already allocate some money towards our standard savings monthly, and we really wouldn't need the additional £885 per annum (£73.75 per month).

Just to complaint a little , it is a shame that every year the government lowers the 20% tax band and reduces the income level at which higher rate tax starts...

Thank you.

dunstonh

Just to complaint a little , it is a shame that every year the government lowers the 20% tax band and reduces the income level at which higher rate tax starts...

The impression is that the Conservatives want to extend the band again. However, Liberals wouldnt allow it. Labour would just accuse the Govt of helping millionaires. The perception of the wider general public is that anyone earning into higher rate tax is a banker and earning a fortune. So, politically, it is difficult at this time for the Govt to make the gap bigger again.

jamesd

AT_London wrote: »

we are closer to our thirties, just bought a flat with 80% LTV, and trying to find a balanced plan to redistribute our money: put it in the pension pot versus overpay the mortgage versus put the cash in ISA etc?

80% LTV is pretty good but interest rates tend to continue to drop all the way down to 60% LTV, though with gradually decreasing differences.

The LTV interest rate changes can be very interesting because a lower interest rate affects all of the money borrowed. So if you borrowed say £10,000 less you could save perhaps 0.2% on £90,000. That'd be an effective interest rate of 1.8% tax free. Not great but the difference in interest rates can be larger and so can the amount borrowed.

So one thing to do is investigate how much you could "make" from the extra payments on a new mortgage with lower LTV.

You can also achieve that sometimes using credit cards at 0% to get you to a LT threshold more quickly. The credit card borrowing will reduce affordability but that may be offset by the lower LTV.

greenglide

anyone earning into higher rate tax is a banker and earning a fortune

Anyone earning over £40k (irrespective of pension payments to bring it down) is earning a fortune IMHO. If I cannot access this income level why should others?

(Quickly leaves the room!)

Spidernick

Your_Hero wrote: »

He/She would lose 42% (2% NI).

Doesn't that depend on whether it's a 'smart' pension or not? If not then there's no avoiding the 2% NI and so effectively 'only' 40% would be lost (I see where you're coming from though).

If the OP is planning to have kids in the future then the potential savings are even greater if he starts earning between £50K and £60K, as child benefit claw back can then be reduced/avoided by lowering salary through pension payments (mine is currently 40% tax, 2% NI - I am in a smart scheme - and 24.75% child benefit saved with three kids, so a whopping 66.75% overall!).

Greenglide, £40K is far from being a fortune in this day and age.