How to get maximum tax efficiency on that 'just over 100k' income slice

ratechaser

First world problem time...

My wife is likely to have gross taxable income in the 100-125k range this year, after taking her occupational pension into account. It's hard to be precise as a chunk of that comes from a bonus paid at the end of Feb, and her employer does not allow further AVCs into the pension.

So she's likely to end up getting some income that falls in that nasty 62% effective tax band, and my thought is that she could open a personal pension to put that excess into and reclaim the tax (although I realise that the 2% NI isn't reclaimable).

Where I'm struggling is with the numbers. Let's say her gross taxable income ends up being 120k. How much would she need to put into a pension to recover the 60% tax that has been paid on that 20k? I realise that the first 20% of tax is an automatic gross up on paying into the pension, then the next 20% would be reclaimed through a tax return. But the final 20% is a hit that you take through a reduction on your personal allowance, so would that also get corrected through her tax return?

In theory it sounds like she should only need to pay 8k in to be able to get back to her original 20k gross position through gross up, self assessment rebate and tax code corrections.... but I have a nagging feeling that's not right. Can anyone cleverer than me advise please

Dazed_and_confused

As this is going to be a contribution to a "relief at source" pension she would need to contribute £16k. The pension company (courtesy of HMRC) then adds in the 25% uplift so she has £20k in the pension fund.

The £20k then has two impacts on her personal income tax position.

1). It reduces her adjusted net income. Which is what her Personal Allowance is based on. In your example that would being her adjusted net income to £2 less than the starting point for her Personal Allowance to be reduced so she would get the full £12,500 (current tax year).

2). It does not reduce her taxable income. But does increase her basic rate tax band meaning more income will be taxed at basic rate and less at higher rate.

Any tax relief due as a result of this can come back to your wife in two ways. A revised tax code for the current tax year or through her Self Assessment calculation.

HMRC never allow tax relief in respect of pension contributions made in one year through the tax code of a different tax year. But when she files her 2019:20 tax return they may amend her 2020:21 tax code on the assumption that the same pension contributions will be made again in 2020:21.

Overall her £16k outlay becomes a £20k pension fund and ultimately only really costs her £8k.

You should Google adjusted net income as all sources of taxable income need to be taken into account. For example (non ISA) savings interest and dividends, if she has any need to be included. These may be taxed at 0% courtesy of the savings and dividend nil rates of tax (commonly known as the Personal Savings Allowance and Dividend Allowance) but they are still part of her taxable income and adjusted net income.

Dazed_and_confused

The "60%" tax relief is essentially split into three,

20% basic rate relief added to the pension fund
20% from getting the Personal Allowance back
20% from paying more tax at basic rate and less at higher rate

Will be more than 60% if she is Scottish resident for tax purposes.

ratechaser

Dazed and Confused - thank you, that's a lot clearer, and especially in respect of the tax coding element. She got caught in the same situation last year and didn't take any action on the pension so already has a K tax code through a combination of personal allowance erosion and savings interest. So what would happen is:

1) Pay in 16k to a pension
2) Pension grosses up to 20k
3) Self assessment will allow for a further 4k tax relief/rebate on the pension payment
4) Self assessment should also then allow for a positive tax coding adjustment for the 20/21 tax year which will have an effective £4k net income benefit relative to where she is this year

Think I've got it now!

Dazed_and_confused

We've got crossed wires somewhere!

1). Seems logical given the apparent tax benefits and future pension benefit

2). Yes

3). No. It all depends on the exact figures and it is highly unlikely to be that simple (figures wise) but if she compares her Self Assessment calculation without the relief at source pension contribution and then with it she should see a £8k difference

4). No. The revised 2020:21 tax code would be allowing provisional tax relief for 2020:21. It has nothing to do with 2019:20 (other than using the 2019:20 contribution as an estimate). The coding adjustment would potentially allow another £8k tax relief. This time for 2020:21. So there would be less to balance up on the 2020:21 Self Assessment return

ratechaser

Lordy. Oh well at least this sort of confirms my suspicions that it's not simple.

But leaving the coding aspect aside, I thought the higher rate relief/rebate aspect would at least be pretty black and white. If you're a HR taxpayer and declare that you've made a
16k pension payment on your self assessment, I'd have thought it would be a case of HMRC saying

"ok, so she's got 20% relief already through gross up, so we give her back the other 20%, i.e. 4k, as a rebate."

Why wouldn't it be that simple?

Dazed_and_confused

If you're a HR taxpayer and declare that you've made a 16k pension payment on your self assessment, I'd have thought it would be a case of HMRC saying

"ok, so she's got 20% relief already through gross up, so we give her back the other 20%, i.e. 4k, as a rebate."

Why wouldn't it be that simple?

Well apart from the fact that it's not what the tax legislation says the main reason is that would mean you could pay £0.40 in higher rate tax (£1 x 40%) and get a £4k refund.

Higher rate tax relief on pension contributions is generally seen as generous on this forum but that would be taking it to extremes

ratechaser

Dazed_and_confused wrote: »

Well apart from the fact that it's not what the tax legislation says the main reason is that would mean you could pay £0.40 in higher rate tax (£1 x 40%) and get a £4k refund.

Higher rate tax relief on pension contributions is generally seen as generous on this forum but that would be taking it to extremes

Yes that would be pretty extreme, but it wasn't what I was suggesting. Or at least I don't think it was. My brain is already overheating...

What I'm saying is that you put down a 16k pension contribution on your self assessment. At the same time, HMRC can see that you've already paid plenty of income tax at the 40% rate through PAYE. So I'd have thought the self assessment calculation would automatically apply a rebate on that 16k, to take into account that it's only had Basic tax relief applied already.

Dazed_and_confused

I think the problem here is that you are imagining a form of pension tax relief that doesn't exist.

When you contribute to a "relief at source" pension the pension company (courtesy of HMRC) add the basic rate tax relief. In your example that takes the £16k contribution to a gross amount of £20k.

No additional fixed "pension" tax relief is due.

What the gross contribution does is have the potential to reduce the amount of your personal tax liability be increasing the amount of basic rate tax you can pay. Which in turn can reduce the amount of higher rate tax payable.

In a very simple situation this may well mean the gross pension contribution saves another 20% but there is no such thing as a flat "extra 20%", the benefit is seen when calculating your personal tax liability.

On a Self Assessment calculation the only difference you would see is that the basic rate band had been extended from say £37,500 to £57,500. And as a result a lot more 20% tax would be payable. And less 40% tax. If the overall income was large enough.

ratechaser

Dazed_and_confused wrote: »

I think the problem here is that you are imagining a form of pension tax relief that doesn't exist.

When you contribute to a "relief at source" pension the pension company (courtesy of HMRC) add the basic rate tax relief. In your example that takes the £16k contribution to a gross amount of £20k.

No additional fixed "pension" tax relief is due.

What the gross contribution does is have the potential to reduce the amount of your personal tax liability be increasing the amount of basic rate tax you can pay. Which in turn can reduce the amount of higher rate tax payable.

In a very simple situation this may well mean the gross pension contribution saves another 20% but there is no such thing as a flat "extra 20%", the benefit is seen when calculating your personal tax liability.

On a Self Assessment calculation the only difference you would see is that the basic rate band had been extended from say £37,500 to £57,500. And as a result a lot more 20% tax would be payable. And less 40% tax. If the overall income was large enough.

Thanks. So it sounds like the same thing in effect then - there will have been at least 20k of income that had been taxed at 40%, and the extension of the 20% band you set out should mean that she would receive a rebate of the higher rate tax that had already been paid on that through PAYE...