Any downsides to increasing pension contributions and moving from a HR to BR tax band?

gtat

Hello,


I am confused by the impact of increasing pension contributions on both income tax and pension tax relief (and any other impacts I haven't considered?), and would be grateful for your views and input to untangle my confusion.


Firstly, some background information:

• I am 33 years old. I earn £50,000 per year, and receive an annual bonus of 0-10%. This is my first year in the role, but I anticipate the bonus to be approximately £3,000 per year. I.e. Total annual earnings of approximately £53,000. A civil service pay freeze means this is likely to stay at this level for a couple of years. I am in the Civil Service Alpha Defined Benefits pension scheme.
• My wife is 34 years old. She works for the NHS, is part of the NHS Care pension scheme and she is currently on Maternity Leave, receiving Maternity Allowance (hasn't been with the NHS long enough to get SMP). She will be going back to work part time in January 2022, earning approximately £12,600.
• We had a child in January 2021 are are now claiming Child Benefit. As I will likely earn over £50k, I will have to complete a Self Assessment Tax Return and repay some Child Benefit.

Aim: I am keen to increase my pension contributions so that I pay less income tax, and so that I do not need to return any of the Child Benefit that my wife receives. From what I understand, increasing pension contributions would increase the value of my Basic Rate tax band, as oppose to decreasing my taxable earnings. But apologies if my interpretation or wording of this is incorrect.


Options: I am in the Civil Service Alpha Defined Benefits pension scheme. As such, I believe I have the following routes to increasing my pension contributions, which would all potentially put me in the BR tax band and also allow us to claim the full Child Benefit entitlement:

1. Civil Service AVC 
2. Added Pension
3. EPA
4. Start a SIPP 

I need to carefully consider which of the four options above I take. My wife and I aspire to retiring at around 58, so the current view is that a SIPP may be the best option for 'bridging the gap' to our Defined Benefit pensions. In reality, we will probably do a combination of the above options i.e. pay into a SIPP but also EPA. I will consider this further in the coming months.


Question: Before deciding on what options I take for increasing pension contributions, are there are downsides or drawbacks to increasing my pension contributions, other than of course receiving less 'take home pay' now? For example, if I become a 'Basic Rate' tax payer, I understand that would mean I pay less income tax, but would I receive less of a top up from Government on my pension contributions (i.e. at 20% rather than 40%?)? 

lisyloo

The major downside to be aware of is that you cannot touch this money until you are 57 (if it's in a pension doesn't apply to the SIPP).

The only 3 ways this money will be released is death, retirement after 57 or terminal illlness.

so if you fall on hard times or want to start a business you cannot touch it.

This is the trade off for the tax relief.

jem16

gtat said:

Question: Before deciding on what options I take for increasing pension contributions, are there are downsides or drawbacks to increasing my pension contributions, other than of course receiving less 'take home pay' now? For example, if I become a 'Basic Rate' tax payer, I understand that would mean I pay less income tax, but would I receive less of a top up from Government on my pension contributions (i.e. at 20% rather than 40%?)? 

First and foremost how much do you contribute to your Civil Service pension as that is already reducing your taxable income?

Secondly how the tax/top up is concerned it depends on what you’re going to contribute to. If it’s additional pension then it will be through reduced tax just like it is just now. If it’s through a SIPP or AVC then the provider would add the 20% tax relief and you then claim any additional tax relief due at 40%. This extra tax relief would be in a reduction of tax. Do remember though that you only get the higher rate tax relief on any higher rate tax you pay. 

Albermarle

The major downside to be aware of is that you cannot touch this money until you are 57 (if it's in a pension doesn't apply to the SIPP)

SIPP = Self Invested Personal Pension , so all pension rules apply . As the OP is only 33 , the age at which their pension can be taken will probably have risen to  more like 60 by the time they get there.

gtat

jem16 said:

gtat said:

Question: Before deciding on what options I take for increasing pension contributions, are there are downsides or drawbacks to increasing my pension contributions, other than of course receiving less 'take home pay' now? For example, if I become a 'Basic Rate' tax payer, I understand that would mean I pay less income tax, but would I receive less of a top up from Government on my pension contributions (i.e. at 20% rather than 40%?)? 

First and foremost how much do you contribute to your Civil Service pension as that is already reducing your taxable income?

Secondly how the tax/top up is concerned it depends on what you’re going to contribute to. If it’s additional pension then it will be through reduced tax just like it is just now. If it’s through a SIPP or AVC then the provider would add the 20% tax relief and you then claim any additional tax relief due at 40%. This extra tax relief would be in a reduction of tax. Do remember though that you only get the higher rate tax relief on any higher rate tax you pay. 

Thanks @jem16 . My March 2021 payslip is as follows:

• Gross pay: £4166.67
• Alpha pension: -£227.09
• NI: -£404.96
• Income tax: £-574

So my pension contributions are approx. 5.45%.

I'm confused about your final paragraph - of the scenarios you describe (i.e. tax reduced through salary vs provider adding tax relief and me claiming additional relief), is one of them financially preferable? Or should it work out the same?

Albermarle said:

The major downside to be aware of is that you cannot touch this money until you are 57 (if it's in a pension doesn't apply to the SIPP)

SIPP = Self Invested Personal Pension , so all pension rules apply . As the OP is only 33 , the age at which their pension can be taken will probably have risen to  more like 60 by the time they get there.

Thanks @lisyloo and @Albermarle . 'Only' 33 - that is very nice to hear! I feel old..!

jimi_man

Hi

You are in the Alpha scheme with a 5.45% contribution rate, which is £2725 a year. So with total earnings of £53K (including your bonus), the reduction of  your pension contributions takes you to £50275 which is £5 over the threshold. So HR tax isn't really an issue - depending on your bonus.

But to answer the original question, yes it's a great idea. I do it, as do many others. I pay into Alpha and also EPA, and then everything else that is above the HR threshold I put into a SIPP to avoid HR tax completely. I pay monthly into the SIPP with a yearly one off payment in mid March, when I know what the figures are exactly.  

However I am over 55 so I can have it technically whenever I want, when obviously you'd have to wait until 55 or 57. 

Also if you are going to be an HR payer in retirement then that makes a difference in how much value you get from the extra pension contributions. 

jem16

gtat said:

jem16 said:

gtat said:

Question: Before deciding on what options I take for increasing pension contributions, are there are downsides or drawbacks to increasing my pension contributions, other than of course receiving less 'take home pay' now? For example, if I become a 'Basic Rate' tax payer, I understand that would mean I pay less income tax, but would I receive less of a top up from Government on my pension contributions (i.e. at 20% rather than 40%?)? 

First and foremost how much do you contribute to your Civil Service pension as that is already reducing your taxable income?

Secondly how the tax/top up is concerned it depends on what you’re going to contribute to. If it’s additional pension then it will be through reduced tax just like it is just now. If it’s through a SIPP or AVC then the provider would add the 20% tax relief and you then claim any additional tax relief due at 40%. This extra tax relief would be in a reduction of tax. Do remember though that you only get the higher rate tax relief on any higher rate tax you pay. 

Thanks @jem16 . 

I'm confused about your final paragraph - of the scenarios you describe (i.e. tax reduced through salary vs provider adding tax relief and me claiming additional relief), is one of them financially preferable? Or should it work out the same?

There’s not really much difference. It’s more down to the type of pension you intend to use how it’s handled. 

cloud_dog

jimi_man said:

Hi

You are in the Alpha scheme with a 5.45% contribution rate, which is £2725 a year. So with total earnings of £53K (including your bonus), the reduction of  your pension contributions takes you to £50275 which is £5 over the threshold. So HR tax isn't really an issue - depending on your bonus.

OP, I think your secondary requirement was to ensure you could benefit from the full CB payment so, you need to be at/below the £50k level for adjusted net income (e.g. after pension cons).

You also need to add on any other BIK to your total taxable income so, if for example you received private medical insurance or a company car, etc, etc.

kidmugsy

You and your wife might each like to make a small subscription to a LISA (Lifetime ISA).  This will reserve your right to make LISA contributions until you are fifty, which might become attractive for (especially) you if the Higher Rate pension tax relief is reduced in future, or if you might come into some money, or if you want to save for subsidising your children for the expenses of, say, a first house purchase.

gtat

Thanks all for the very helpful information.

@kidmugsy I set up a S&S LISA in March, and my wife intends to do the same for this financial year too. So we'll both have the option of paying into LISA's for the next 16 years or so, if finances permit!

@cloud_dog yes that is correct regarding CB. I don't have any other BIK that I can think of.

cloud_dog

gtat said:

@cloud_dog yes that is correct regarding CB. I don't have any other BIK that I can think of.

So, you need to add £275 to your contributions (perhaps a little more just to cover off any variations)  to ensure you get to / below the £50k level to be able to claim CB without any clawback.