Pension contribution to lower tax liability

weimo

Hello All,

Hopefully someone can offer some opinions / advice on my situation. I earn a reasonable salary 45k also receive income from property of net rental income 9k plus some equities with div of 5k.

I opt into an employee pension scheme under new government rules, but I feel I would benefit tax wise to increase my contribution as to place myself as a basic rate tax payer? Does it work like this with tax relief?

If I increase my pension contribution to bring my salary and other income streams to total under the threshold for higher rate, My question is whether I have understood this correctly?

Thanks in advance,

Dazed_and_confused

It is possible for pension contributions to move you from being a higher rate payer to a basic payer (or higher rate to intermediate rate if Scottish resident for tax purposes).

However there are three main methods of contributing to a pension and they all work in slightly different ways so you would have to understand how you intend to contribute to be able to understand the consequences form a tax perspective.

The three are,

Net pay (deducted from gross pay before tax is calculated)

Relief at source (pension company adds basic rate tax relief)

Salary sacrifice

Which will you be paying?

weimo

I do not know the answer to this question I will find out. It's either of the first two stated.

When I look at the annual pension statement it adds tax relief to the amount deducted from my monthly payslip. So I believe the second option you mention?

I do know that I will have to make a huge drop in take home pay over the next 5 months to achieve this.

Dazed_and_confused

Assuming the £45k you quoted is the taxable amount which would go on your P60 then you have taxable income of £59k.

£2,000 of which will be taxable at 0% (the dividend nil rate).

Contributions under a net pay scheme are very simple, they reduce your taxable pay so for example say your "salary" was £48,000 and you contribute 10% then your taxable pay, the amount that goes on your P60, would only be £43,200.

Relief at source contributions do not reduce your taxable income. But they do increase the amount of basic rate tax payable. Which can in turn reduce the amount of higher rate tax payable.

For example if you contribute £4,000 to a relief at source scheme such as a personal pension or SIPP then the pension company, courtesy of HMRC, will add 25% to give you £5,000 in your pension fund.

This increases the amount of basic rate tax you can pay from £37,500 to £42,500. This can mean an extra £5,000 of your income would be taxed at 20% rather than 40%, saving you £1,000 in your personal tax bill (£5,000 x 20% = £1,000).

So ultimately the £5,000 in your pension fund has really only cost you £3,000.

Salary sacrifice is similar to net pay in that it reduces your taxable income but you don't actually contribute to the pension, your employer does.

weimo

Thank you for the detailed reply. So how will I tell which camp I fall into? Are there any obvious sign on a payslip I should look for?

Dazed_and_confused

Net pay reduces the amount that gets taxed.

Salary sacrifice reduces the amount that gets taxed and the amount National Insurance is paid on

Relief at source doesn't reduce either, you pay tax on the full salary amount and the pension amount is deducted from your net of tax/NI pay.

Best check with your employer to be certain though. Or look at your pension scheme booklet/documents.

weimo

It states the pension provider adds 20% tax relief to the employee contribution.

So my understanding is that would be relief at source?

Dazed_and_confused

Sounds like it yes.

They actually "add" 25%, which is 20% tax relief.

Contribute £100 and they add £25 giving a gross contribution of £125.

£25 is 20% of the gross contribution of £125

weimo

So would I be able to achieve the 20% basic rate under this scheme if I dramatically increase my contribution now? I've only been paying 4% so far this tax year.

Dazed_and_confused

Yes.

You have to include the pension contribution on your Self Assessment return and when you look at your tax calculation you should that the basic rate band has been increased by the amount of your gross contribution.

weimo

The current limit is 50k so I would require my annual pension contributions to total 7.5k for the year to bring the 57k taxable under the threshold?