Reducing tax using pension contributions?

judi24

Although I am a little premature I am trying to work through a plan of how best to use my income once my debt is paid off in a few months.




I wanted to over pay my mortgage to reduce term with the aim of retiring early (in around 10 years at 57) - I currently earn around 49k after pension contributions (I work in the NHS so have a reasonable pension but only had it 17years) - last year I paid 40% tax on around 7k of my salary and I wondered if increasing my pension payments would reduce this amount or whether the it would come back and bite me (ie end up paying it anyway when I draw my pension lump sum) or whether I should leave my pension as it is and just overpay the mortgage?
As you can see I really have no idea about pensions/tax as my focus for many years has just been to get out of unsecured debt! Now I need a new plan to gain financial independence and retire! Any help would be appreciated

jem16

judi24 wrote: »

last year I paid 40% tax on around 7k of my salary and I wondered if increasing my pension payments would reduce this amount

Yes it would.

However it doesn't have to be paid into the NHS pension. You could decide to pay into a Personal Pension which could allow you to retire earlier than the NHS pension allows which you have said you would like to do.

or whether the it would come back and bite me (ie end up paying it anyway when I draw my pension lump sum)

Your lump sum would be tax-free. You annual pension would be liable to tax just like your earned income is now. Unless your pension is likely to be over £43k you won't pay tax at 40% but 20% instead. So you are likely to gain.

or whether I should leave my pension as it is and just overpay the mortgage?

Pension contributions which give you 40% tax relief but only likely to pay 20% in retirement are going to be much better.

judi24

Thank you Jem - That is really helpful.


So just to clarify - if I put the 7k into a pension (NHS or otherwise) I would essentially save the 40% I currently pay in tax (just short of 3k) a year more than if I simply saved the 7k or over payed the mortgage (currently at 1.99% interest rate but I will hope to remortgage to a better rate)?

jem16

judi24 wrote: »

So just to clarify - if I put the 7k into a pension (NHS or otherwise) I would essentially save the 40% I currently pay in tax (just short of 3k) a year

You would get 40% tax relief, yes. The method you get this relief will vary depending on the type of pension you use though.

more than if I simply saved the 7k or over payed the mortgage (currently at 1.99% interest rate but I will hope to remortgage to a better rate)?

Yes.

judi24

Thanks Jem - really helpful! But Lots more to learn I think! I have been quite naive about pensions, tax etc as I just thought I paid into my work one that seems ok so why worry!!! Its only when I started to look a little wider at my financial goals that I realised how interconnected things are!!!

MDMD

Bear in mind that the rules could change in the not too distant future on whether you get 40% relief on pension payments. There is a thread running at the moment on this.

https://forums.moneysavingexpert.com/discussion/5386421

judi24

Thanks MDND- I had a read and I guess there is huge amount of uncertainty - I wont be doing anything until after April so at least I will know what surprises the next budget might hold! After that supposing the 40% tax relief still exists am I right in assuming that if I plough more into a pension and things change I can review the situation and change plan accordingly? so stop paying additional pension and start increasing mortgage overpayments or savings? I guess its a bit of a gamble either way!!!

xylophone

You might consider a SIPP - HL is not the cheapest but staff helpful and web site excellent.

http://www.hl.co.uk/pensions/sipp/tax-benefits-of-a-sipp

You can choose how and when you contribute.

You might find this helpful. http://monevator.com/cheapest-pension-diy/