Pension Sweet Spot (40% tax)

SteveyJC

Hi All,
Either my brain is not working, or it's too much quarantine lockdown, but how do I calculate the maximum I can put into my pension to. take advantage of the 40% tax relief?

I earn approx £65k, and between my employer and myself, put 20% of earnings into my pension. How much extra can I put into a SIPP to max out the 40% tax relief from government?  Is it equivalent to £65,000 - 50,001?  

Thanks,, 

Albermarle

Do you know how your regular contributions are made - is it by salary sacrifice and how much of the 20% is your personal contribution ?

bowlhead99

If you already put 20% of the £65k into your pension, you are not paying high rate tax on that money anyway. So you don't have as much as £15k of remaining capacity to save 40% tax (65k-50k), because you aren't paying tax on the full 65k in the first place.

To keep it simple, let's imagine you and your employer are each putting 10% of your £65k gross earnings into your pension. So the money coming from you is 10% of £65k, or £6500. So the money you are paying high rate tax on at the moment is the difference between (£65,000 - 6,500 = 58,500) and the 50,000 higher rate threshold. So, 8500 is the amount of gross pay that you would look to put into a pension scheme to avoid paying 40% tax on anything.

If you put £6800 into a private pension, the pension provider will claim £1700 of basic rate tax relief for you and you will end up with £8500 in the pension pot (because £6800 is 80% of £8500, and basic rate tax is the other 20%). You can tell the tax man at the end of the year that you have made £8500 of personal pension contributions (cash contribution plus the basic rate relief) and they will extend your basic rate band to account for it, meaning £8500 of income drops out of the higher rate band and into basic rate. This means you'll have paid too much tax in the year via PAYE so will get some back.

In the example, you'd get £1700 back from the tax man into your bank account in relation to this extra contribution, so that you've only paid £5100 from your bank account (£6800 out and £1700 back from HMRC), while you have £8500 of pension assets. If those £8500 of extra pension assets cost you £5100, you have effectively got a full 40% relief on the £8500 of gross contributions.

If your employer offers a scheme where they will take money off your pay gross and put it into your workplace pension instead (which is how it works in e.g., salary sacrifice or salary exchange scheme) then you will save the faffing about with having to tell the taxman how much you paid into the pension, because you'll already have been taxed via PAYE on your reduced gross salary and there's nothing further to do.

SteveyJC

Thank you @bowlhead99 for that! Much appreciated!

@Albermarle Thank you also,  It's 9% them, 11% me. I think I should be able to work it out now. Thanks!

michaels

If you can do salary sacrifice and they will donate some of the employers NI then it is not necessarily a problem to go below the higher rate threshold (on Sal sac basic rate you save 20% tax, 12% NI and if the employer gives most of their 13.8% NI then you still do as well as the 40% income tax saving for SIPP contributions)

Even at higher rate sal sac wins as you also get the 2% NI saving and could get more if the employer will split the employers NI saving. 

SteveyJC

Thanks @michaels   I'm fairly sure they won't do the salary sacrifice :-( 

Do other benefits such as a company car/ private health impact the amount you can put into the pension, or are those amounts totally separate? 

MEM62

SteveyJC said:

Thanks @michaels   I'm fairly sure they won't do the salary sacrifice :-( 

Do other benefits such as a company car/ private health impact the amount you can put into the pension, or are those amounts totally separate? 

Why not? It saves your employer money as well as you.  It's what is called a no brainer.  

Albermarle

Salary sacrifice is a loophole that benefits employee and employer.

michaels

SteveyJC said:

Thanks @michaels   I'm fairly sure they won't do the salary sacrifice :-( 

Do other benefits such as a company car/ private health impact the amount you can put into the pension, or are those amounts totally separate? 

afaik they are separate but do form part of your taxable income (or the bik does) so they are added on to what you earn when working out what the cut off point for 40% pension tax releif would be.  Don't take my word for it though.

MEM62

Albermarle said:

Salary sacrifice is a loophole that benefits employee and employer.

It is not a loophole.  It is an allowable and legitimate scheme under HMRC rules.  

Albermarle

It is not a loophole.  It is an allowable and legitimate scheme under HMRC rules.  

A tax loophole is by definition allowable and legitimate .Collins dictionary >>

'a legal way of avoiding the payment of tax, or part of a tax bill, due to a gap in tax legislation'

It is probably a matter of opinion whether Salsac constitutes a gap in legislation, but for sure it was never intended that salary sacrifice would be used on such a large scale for pensions, allowing large scale avoidance of NI payments. One day this loophole/avenue/legislation  will be most likely closed./changed.