Overpay into Pension

guitarman001

Who does this in order to bring them out of 40% tax bracket (for savings interest etc)? Just curious... Would like to build my savings for a home at some point and overpaying into pension would limit this, but at the same time would like to do that to get around having to submit a tax form at year end for the extra 20% tax on accounts...

peterg1965

I do, but it is largely to avoid losing my tax free personal allowance. Of course, its not just that, it is to build a bigger retirement pot, which is the primary objective.

ratechaser

By 'overpay', do you mean make additional contributions to whatever the standard is with your employer, or are you talking about paying more than the £40k annual allowance to take advantage of prior year unused allowance?

I've done both by the way and provided you can live without the money until you're 55 (or possibly slightly older depending on your age as the rules on early retirement access are changing, will be 57 before I can access it), then to me it's by far the best way of investing for the future. Even more so if your employer operates contributions on a salary sacrifice basis because you also save on the 2% of uncapped NI contributions that I'm guessing you are also subject to.

Given the effect of all that plus the effect of my employers own contributions, £40k of pension per year only costs me the equivalent of about £14k of net pay. Clearly you need to watch what it's being invested in, and in fairness I'm getting an extra lift as it's actually reducing my tax liability by 47% (45% tax and 2% NI), but it's something that seems a no-brainier to me...

peterg1965

ratechaser wrote: »

I've done both by the way and provided you can live without the money until you're 55 (or possibly slightly older depending on your age as the rules on early retirement access are changing, will be 57 before I can access it),

Can you expand on this comment please? Are you saying that the age at which pensions can be accessed is going up from 55? The first I have heard of this.

guitarman001

I mean making extra contributions. Employer pays 9%, I pay 10% currently. Thing is being younger I want to save for a house and it'd reduce my income by a fair bit in order to be taken out of the 40% band. Also, the pension could just under-perform or disappoint at retirement (if I get there) etc...
I guess my main gripe is that the 40% band is "so low" - it's really ridiculous.

Basically I'd be several hundred pounds lighter net of tax in my pocket... in exchange for taking me out of the 40% bracket. Assuming pension works out it'd be worth it financially but to be honest it's largely to take the hassle out of having to send a tax return in every year..... it's a bummer to get 6% on P2P sites only to be reduced by FORTY PERCENT tax at year-end. And it's not like I'm on mega-bucks! Grr!

ratechaser

peterg1965 wrote: »

Can you expand on this comment please? Are you saying that the age at which pensions can be accessed is going up from 55? The first I have heard of this.

Ah, interesting, I may have to take that back - it was a planned change but looks like it might not be going ahead. If so, happy days as my birthday meant that I could have been a victim of this by a of a mere few days...

http://www.thisismoney.co.uk/money/pensions/article-2967477/Pension-age-increase-axed.html

ratechaser

guitarman001 wrote: »

I mean making extra contributions. Employer pays 9%, I pay 10% currently. Thing is being younger I want to save for a house and it'd reduce my income by a fair bit in order to be taken out of the 40% band. Also, the pension could just under-perform or disappoint at retirement (if I get there) etc...
I guess my main gripe is that the 40% band is "so low" - it's really ridiculous.

Basically I'd be several hundred pounds lighter net of tax in my pocket... in exchange for taking me out of the 40% bracket. Assuming pension works out it'd be worth it financially but to be honest it's largely to take the hassle out of having to send a tax return in every year..... it's a bummer to get 6% on P2P sites only to be reduced by FORTY PERCENT tax at year-end. And it's not like I'm on mega-bucks! Grr!

If you're not on a massive salary, why would you expect to have to complete a tax return? To the best of my knowledge I didn't think these kicked in as soon as you hit the 40% band?

ColdIron

I do this and haven't paid HR tax for some years. I'm older than you and my circumstances differ but since Osborne's pension changes last year where I am not restricted to an annuity I have maxed out my annual contribution. The money would only be invested in a similar portfolio outside the tax wrapper anyway so if you can afford it, it seems a bit of a no brainer to make hay while the sun shines (though Balls worries me as he has form on pensions). 100% tax relief on contributions plus lower NI if done via salary sacrifice, no tax on dividends, no extra tax on interest, lower CGT if you can't avoid it, what's not to like?

PS this wouldn't necessarily remove the need for doing a self assessment especially if not done via salary sacrifice

tigerspill

guitarman001 wrote: »

Who does this in order to bring them out of 40% tax bracket (for savings interest etc)? Just curious... Would like to build my savings for a home at some point and overpaying into pension would limit this, but at the same time would like to do that to get around having to submit a tax form at year end for the extra 20% tax on accounts...

I have just started exactly this.
In February I made a one off payment into my AVC. The figure used was the amount I was due to pay in 14/15 at 40% HRT. Since last month I do this via sacrifice - calculated again to avoid being a HRT tax payer.

bowlhead99

guitarman001 wrote: »

I mean making extra contributions. Employer pays 9%, I pay 10% currently. Thing is being younger I want to save for a house and it'd reduce my income by a fair bit in order to be taken out of the 40% band. Also, the pension could just under-perform or disappoint at retirement (if I get there) etc...
I guess my main gripe is that the 40% band is "so low" - it's really ridiculous.

Basically I'd be several hundred pounds lighter net of tax in my pocket... in exchange for taking me out of the 40% bracket. Assuming pension works out it'd be worth it financially but to be honest it's largely to take the hassle out of having to send a tax return in every year..... it's a bummer to get 6% on P2P sites only to be reduced by FORTY PERCENT tax at year-end. And it's not like I'm on mega-bucks! Grr!

I think if you are looking at extra pension contributions as being some all-or-nothing, pay enough to drop out of the 40% band or don't pay anything, then you're missing the point.

Say you are on £45k salary. The higher rate tax threshold of personal allowance plus basic rate band is £42,385. If you put £3k of gross pay into a pension (£250 a month), your taxable income is only £42k. In doing that, you will avoid paying 40% tax on £2,615 of the £3000 and avoid paying 20% tax on the other £385 of the £3000. And so the £1123 of saved tax means the £3000 of pension assets only costs you £1877 from your net pay, or £156 a month of takehome pay to buy £250 a month of pension assets.

It's a great deal, because the £3000 of pension assets will grow tax free, and at some point in the future you can take a tax-free lump sum out of them, and then pay your marginal rate of tax on the balance, which might be 0% or 20% depending how much other money you are earning when you take the money. So basically you save almost 40% tax on the £3k now and might only need to pay 15% tax or something when you take it later.

A useful side effect is that by paying the money into your pension you have got your net taxable salary down to £42k which dropped you out of higher rate tax and into lower rate tax on every new pound of income you earned (until you get back up to £42385 and start paying higher rate tax again). So if you have a second job or some interest income or dividend income or whatever, you are only facing the 'basic rate' levels of tax on that, instead of higher rate, until you earn the £385.

So, being in a position to only pay basic tax on savings income or other income is a nice effect of having made a big pension contribution that overshoots the high rate threshold.

But it's not a binary choice where you have to either get down to basic tax rate or not bother. You could instead have chosen to make £2400 gross pension contributions, £200 a month instead of £250. You would be left with a taxable salary of £42600 and would have saved high rate tax on all the money - the £2400 or £200pm gross only costs £1440 or £120 a month net. You have still made a very efficient contribution to your pension assets, still saving 40% tax now and likely paying much less than that on them in retirement.

You didn't get as far as 'using up' all your higher rate allowance so you are still paying high rate tax on your interest income and dividends and pay rises and bonuses etc - but that doesn't mean you have failed to do anything useful and shouldn't make the pension contribution at all. You have saved a big chunk of tax on your salary.

Consider someone on £80k. If they and their family have a lifestyle that relies on that level of annual income, they are unlikely to be able to contribute £38k of gross salary as extra pension contributions to get them down to £42k and basic rate tax. Maybe they can do £2500 a month at a net cost of £1500 a month. Maybe they can do £250 a month at a net cost of £150 a month. Maybe they can do £200 a month at a net cost of £120 a month. But they probably can do something.

None of those levels of contributions would break that person out of high rate tax on their interest or dividend income or payrises or bonuses or private business income, but they are still saving 40% tax on as much as they can afford to put away. Assuming they then pay less than 40% on it in retirement, it is a win. The 'cost' is a loss of flexibility because once it's in the pension wrapper, it can't come out again until age 55 (or 57 or 58 or whatever the rule is by the time they reach it).

ratechaser wrote: »

Ah, interesting, I may have to take that back - it was a planned change but looks like it might not be going ahead. If so, happy days as my birthday meant that I could have been a victim of this by a of a mere few days...

http://www.thisismoney.co.uk/money/pensions/article-2967477/Pension-age-increase-axed.html

It hasn't been made law yet and maybe it won't be. What has been recommended / mooted is that the age at which you can dip into your personal pension assets should track the age at which we decide state pension is payable, with a 10 year gap. So at the moment it's 55 vs 65 state pension.

We know state pension age will go up and up, to 67, 68 etc. Having a private pension means you could in theory support an early retirement 10 years earlier at the moment, but having heard what's been proposed, it's probably wishful thinking to think you could still access the private pension at 55 when the state pensions are not being paid out before age 70. Anecdotally, advisors are telling people to assume getting the money out at 55 may not be possible, it will need to tick up a little as time goes on. So if you think you'll be in the group that can only take state pension at 67+, probably safer to assume personal pension at 57+.

ratechaser wrote: »

If you're not on a massive salary, why would you expect to have to complete a tax return? To the best of my knowledge I didn't think these kicked in as soon as you hit the 40% band?

You have to complete a tax return if HMRC send you one (which I think is not automatic now until you earn over £100k).

You have to tell HMRC if you are a higher rate payer who earns interest income that they need to pay tax on (e.g. you only had 20% taken off you by the bank or 0% taken off you by a p2p lending firm, and you're in the 40% bracket).

Similarly if you are in the higher rate bracket and owe tax on dividend income received outside an ISA, you need to tell HMRC.

Similarly if you make capital gains in excess of the £11,100 annual allowance or you have total disposal proceeds over £44,400.

Similarly if you have rental income or other business income.

Similarly if you have made contributions to a personal pension which was not one where your money was taken gross from salary, and you paid it over to a pension provider who is only allowed by law to gross it up for basic rate tax, while you are higher rate tax and need to claim the difference.

Similarly if you made charitable donations where, as with the pension, the charity can only get a gift aid gross up for basic rate tax, and you want your extra £5 back on that £20 donation you gave to cancer research when your mate did the marathon.

So, those are just a few of the bunch of reasons why you might be doing a tax return once you get to the 40% bracket. If you are just someone who gets paid via PAYE and don't have many reasons to do a tax return, you can write to HMRC with the details of what your extra income has been or what your extra allowances should be, and whether they're one-offs or not, and HMRC can adjust your tax code and just handle it through changing your monthly payslip. But if you have a few things going on, it can be easy enough to just spend an hour a year pulling them all together and doing the online tax return.

guitarman001

Am I right in saying that interest earned on bank accounts can't push you into a higher tax bracket? So if you're sitting on the cusp of the 40% band and you get £10k interest (yeah, right) per year, that doesn't push you into the higher band.

So other than earned income through employment, what else can push you into the band? Capital gains on shares not in an ISA or property?

It's a real pain having to tell HMRC you have to pay an extra 20% tax on top of the 20% the banks take. Or 40% if P2P as they take nothing at source.It'd be so much easier if the banks just did it for you but I can see the complications.

So anyway! Hmmm....If you earn anything over than £42,385 you should put it all into pension to avoid the higher tax bracket. Tough one...

Great post, by the way!