40% tax relief???

slopemaster

Neither of us has ever been anywhere near paying higher rate tax before, so I’m not sure how it works…

In a year’s time we are likely to be selling a house (jointly owned, inherited from my parents) which has been let out for 5 years.
If I’ve understood the new rules, We will be paying CGT on (part of) the increased value at 28%, because the capital gain is added to our incomes, thus taking both of us over the 40% tax threshold.

So what I was having trouble understanding is, does this mean that if we put some money into our pensions in that year, we could get 40% tax relief on it? Very grateful if anyone can explain!


PS neither of us is employed. My husbands income is from self-employment; mine from rent on property, and next year I will have a pension from an old job. (This is separate from the stakeholder pensions we would be paying into.)

dunstonh

So what I was having trouble understanding is, does this mean that if we put some money into our pensions in that year, we could get 40% tax relief on it? Very grateful if anyone can explain!

Higher rate relief is expected to be abolished in a few weeks time.

At the moment, you can only pay into a pension against earned income. So, your husband is ok but you would be limited to just £3600.

AnotherJoe

AIUI you are incorrect, you pay capital gains tax, it's not add to your incomes.
If it was added to your incomes you'd pay income tax on it.

slopemaster

I know it seems weird.
I could easily be wrong! (And in fact I hope I am...)

But the way I understood it was, they added it to your income, to determine whether you pay CGT at 18% or 28%

slopemaster

Maybe i need to seek clarification on the tax board.

AnotherJoe

I've just had a look, looks as if (unfortunately for you) you are right and I am wrong.
Sorry to have raised your hopes.

1. Work out how much taxable income you have - deduct your Personal Allowance and any other Income Tax reliefs you’re entitled to.
2. Work out your total taxable gains.
3. Deduct your tax-free allowance from your total taxable gains.
4. Add this amount to your taxable income.
5. If this amount is less than the basic Income Tax band (£31,785 for the 2015 to 2016 tax year) you’ll pay 18% Capital Gains Tax. You’ll pay 28% on any amount above this.

CLAPTON

slopemaster wrote: »

Neither of us has ever been anywhere near paying higher rate tax before, so I’m not sure how it works…

In a year’s time we are likely to be selling a house (jointly owned, inherited from my parents) which has been let out for 5 years.
If I’ve understood the new rules, We will be paying CGT on (part of) the increased value at 28%, because the capital gain is added to our incomes, thus taking both of us over the 40% tax threshold.

So what I was having trouble understanding is, does this mean that if we put some money into our pensions in that year, we could get 40% tax relief on it? Very grateful if anyone can explain!


PS neither of us is employed. My husbands income is from self-employment; mine from rent on property, and next year I will have a pension from an old job. (This is separate from the stakeholder pensions we would be paying into.)

you can only get tax relief on pension if you have earned income : neither rent nor cgt count as earned income
you are allowed only 2,880 net (3600 gross) to pay into a pension

kidmugsy

slopemaster wrote: »

does this mean that if we put some money into our pensions in that year, we could get 40% tax relief on it?

No; you won't have paid 40% income tax so there's no 40% tax to avoid. You will have paid a mix if 18% and 28% CGT; I don't know of any way of avoiding that except claiming for all claimable expenses you may have had on the property.

grey_gym_sock

in theory, pension contributions can cut your income tax liability, not your CGT liability. however, in practice, due to the "stacking" of CGT on top of income tax, there can be a knock-on reduction in CGT liability. when this applies, the overall effective tax relief is at 30%, not 40%.

how so?

suppose this is the 2015-16 tax year, and the personal allowance is £11,000, the basic rate band is £32,000, and the CGT allowance is £11,100.

suppose your total taxable income is £21,000, and you also have a chargeable gain of £51,100.

then you will pay £2,000 income tax (at 20%, on the £10,000 above the personal allowance). that leaves another £22,000 of the basic rate band unused (so far).

after setting £11,100 of the chargeable gain against the CGT allowance, you'll pay tax on the remaining £40,000; £22,000 of that is at 18% (using the rest of the basic rate band), and the other £18,000 is at 28%; which comes to £9,000 CGT.

total income tax + CGT due is £11,000.

now what if you contribute £10,000 to a pension? (note that you can only do so if you have earnings - i.e. income from employment + self-employment - of at least £10,000. if your earnings are lower, you can contribute up to 100% of your earnings, or up to £3,600 if your earnings are less than £3,600.)

this pension contribution reduces your income tax liability from £2,000 to nil.

but it also means that none of your basic rate band has been used against your income, so the full £32,000 can be used against chargeable gains. so you now pay 18% CGT on £32,000 of gains, and 28% on the remaining £8,000; which is a total of £8,000 in CGT.

so total income tax + CGT due is now £8,000. (you have cut your income tax liability by £2,000, and your CGT liability by £1,000, a total saving of £3,000.)

on a £10,000 pension contribution that is a saving of 30%. (QED )

kidmugsy

grey_gym_sock wrote: »

now what if you contribute £10,000 to a pension? ... reduces your income tax liability from £2,000 to nil.

But it doesn't, does it? You still pay the £2k income tax, but you get compensation by having £2k relief added to your pension pot.

grey_gym_sock wrote: »

but it also means that none of your basic rate band has been used against your income

I'm not convinced: are you sure that HMRC sees the interaction in this light?

grey_gym_sock

kidmugsy wrote: »

But it doesn't, does it? You still pay the £2k income tax, but you get compensation by having £2k relief added to your pension pot.

the effect is the same. i.e. the result is the same as if you paid no income tax, and paid £10,000 into a pension.

but the actual mechanism is that you pay £2,000 income tax, and pay £8,000 directly into a pension, and then HMRC add £2,000 to the pension.

I'm not convinced: are you sure that HMRC sees the interaction in this light?

you're right that HMRC describe it differently, but again the effect is the same.

if you look at an HMRC tax calculation, it actually says that your basic rate band has been extended (for pension contributions) from £32,000 to £42,000; and that £10,000 of the basic rate is set against your income. which leaves £32,000 which can be used against chargeable gains.