Personal pension option for mitigating 62% tax rate

ratechaser

Hi all,

My OH is going to end up in this tax year (for the first time) with taxable income somewhere between 100k-122k, so will end up paying effective 62% tax on a slice. Her employers pension scheme doesn't allow for ad-hoc AVCs, so we are looking at starting another personal pension to put enough in that will bring her taxable income down to 100k.

These are the mechanics as I understand it, assuming taxable income for the year is 115k. I'm also ignoring the 2% NI as I do not believe that can be recovered:

1) She puts 6k into a personal pension.
2) That 6k is then immediately grossed up to 7.5k with 20% basic tax relief.
3) When she gets a tax return, this pension payment is declared and that would trigger a further rebate of 2.5k, representing 40% tax relief.
4) Additionally, there should also be a further 5k of relief representing the fact that she is no longer losing the majority of her personal allowance from going over 100k of taxable income. However that would not be paid as cash because her tax code does not already reflect this reduction. Instead it would simply mean that her go forward coding for 2017/8 would not be negatively impacted.

Am I correct here?

Also, can anyone give me any pointers on what isna ballpark low charge rate we should be aiming for with a simple personal pension vehicle? She will be able to access this money in 7 years time anyway, so just looking to park it in something low risk.

Thanks
RC

1

dunstonh

1) She puts 6k into a personal pension.
2) That 6k is then immediately grossed up to 7.5k with 20% basic tax relief.

No.
If you put £6000 into pension, it costs you £4800. You make a gross contribution but you pay the net amount.

3) When she gets a tax return, this pension payment is declared and that would trigger a further rebate of 2.5k, representing 40% tax relief.

No.
As the gross contribution was £7500, the basic rate relief at source was £1500. 40% would be a further £1500. However, as it is above £100k, there would be a little more than this as the pension contribution reduces the income by £7500. So, the impact of the personal allowance reduction is less.

4) Additionally, there should also be a further 5k of relief representing the fact that she is no longer losing the majority of her personal allowance from going over 100k of taxable income. However that would not be paid as cash because her tax code does not already reflect this reduction. Instead it would simply mean that her go forward coding for 2017/8 would not be negatively impacted.

The figures in your relief are now more than the actual contribution. Did you perhaps change the figures when writing the post and forget to correct them throughout the whole post? A contribution of £7500 which has already had £1500 relief cannot get a further £5k of effective relief.

HMRC can correct via the tax code in the year the contribution is made (if enough time is given and you tell them in the year). Or they can rebate directly after the tax return or they can make an adjustment in the following years tax code.

Linton

Doesnt sound right. The basic mechanism is correct, but surely if she wants to avoid losing some of her personal allowance she should get 15K into her pension by contributing £12K.

The annual cost of a SIPP is either a fixed sum or a % charge. For a small pension the % charge would be cheaper and is typically 0.25%-0.45% depending on the provider. There may be additional charges for paying out money or closing the account. See here. Personal pensions should be a bit cheaper.

ratechaser

I'm really not getting this I'm afraid!

Ok, maybe it would help to look at it the other way round. 15k of gross taxable income just above the 100k threshold would (ignoring the NI impact) actually become 6k of net income, through a combination of direct taxation and subsequent coding adjustments. My OH's objective is to take that 6k of net income and reclaim the full amount of directly deducted tax, and ensure no subsequent coding change.

I assumed that writing a 6k cheque and paying it into a new pension would achieve that?

Linton

ratechaser wrote: »

I'm really not getting this I'm afraid!

Ok, maybe it would help to look at it the other way round. 15k of gross taxable income just above the 100k threshold would (ignoring the NI impact) actually become 6k of net income, through a combination of direct taxation and subsequent coding adjustments. My OH's objective is to take that 6k of net income and reclaim the full amount of directly deducted tax, and ensure no subsequent coding change.

I assumed that writing a 6k cheque and paying it into a new pension would achieve that?

Wrong assumption. HMRC only refund basic rate tax into the pension, the rest is returned to you, and you cant expect tax relief on money that is returned to you. As Dunstonh indicates, to avoid getting confused you should always think in terms of gross money going into pension and then work out the tax effects. Dont try to work it out from taxed income.

xylophone

http://www.pruadviser.co.uk/content/knowledge/technical-centre/tax_relief_members_contributions/
may assist.

http://www.pruadviser.co.uk/content/57818/354015/annual_allowance_calculator/

Don't forget to take her contributions to her occupational pension into account - presumably the "net pay" system is used - explained in link.

Re "carry forward".
http://www.hmrc.gov.uk/tools/annualallowancelimit/

ratechaser

I really was looking at this the wrong way. Must admit that pensions calculations have always baffled me as throughout my career I've tended to pay in gross through salary sacrifice, so it's been very easy.

Alright. So to maximise relief on that 15k, she writes a cheque for 12k, which is then grossed up to 15k. She directly reclaims another 3k through her tax return, and also avoids 3k on charges through future coding adjustments.

So, 15k gross contributions for an effective net cost of 6k?

ratechaser

Xylophone - yes, will be factoring in her occupational pension, which is done on a salary sacrifice basis. Hence why I was specifically using the term 'taxable income'. As an aside, things like childcare vouchers and other benefits like gym membership are already helping to mitigate her tax situation, but she will still come out somewhere in that nasty 100-122k taxable income band.

As for carry forward and annual allowance, that's one thing I am a bit more familiar with as I was fully maxed out on contributions in my last job. For my OH however, she has plenty of current year headroom, with less than 20k going into her occupational scheme.

kidmugsy

ratechaser wrote: »

So to maximise relief on that 15k, she writes a cheque for 12k, which is then grossed up to 15k.

Yes.

ratechaser wrote: »

She directly reclaims another 3k through her tax return

Yes

ratechaser wrote: »

and also avoids 3k on charges through future coding adjustments

Eh? I've no idea what you are trying to say here.

ratechaser

kidmugsy wrote: »

Eh? I've no idea what you are trying to say here.

So... Every £2 of taxable income between £100k and £122k will reduce your personal allowance by £1, until it's down to zero. Consequently that £15k of gross income going into the pension would otherwise have reduced my OHs allowance by £7500, meaning she would have been hit for another 40% tax on that amount, i.e. £3000.

In my experience, the way HMRC collect that additional tax is to make an adjustment to your tax code for the following year, so that £3000 would be collected incrementally in arrears.

That's what would be avoided by making a £15k gross contribution.

Linton

ratechaser wrote: »

I really was looking at this the wrong way. Must admit that pensions calculations have always baffled me as throughout my career I've tended to pay in gross through salary sacrifice, so it's been very easy.

Alright. So to maximise relief on that 15k, she writes a cheque for 12k, which is then grossed up to 15k. She directly reclaims another 3k through her tax return, and also avoids 3k on charges through future coding adjustments.

So, 15k gross contributions for an effective net cost of 6k?

She gets £3k grossed up, £3k from higher rate tax rebate and she wont have to pay the extra arising from the decrease in the tax allowance. What that is I will leave as an exercise for the reader.

The tax code change merely automates the higher rate tax rebate. Its not an extra.