How much am I actually saving?

Diesel3390

Hi all, 

Trying to put my "clever financial planner" hat on but need a few brains to help me think through this. 😂

The question is about making rental income stretch as far as possible. 

I have a rental property which generates, for example let's say £1,000 a month.

I receive the full gross (pretax) 1,000 each month from my estate agency so I file a self assessment to pay the tax at end of year. Let's say I pay 40% tax, so on each 1,000 I owe 400.

Can you help me think this through:

So for every 600 I earn from rental profit, I am in effect getting 400 as the gross if 1000 is paid upfront by estate agent, then another 400 in tax relief if I put that 1000 into a pension.

I know one response may be: you're already getting 1000 gross rental so you can't apply a tax rebate on it as its already pre tax. But if I pay the 1000 from my work salary instead then it's all just a mental framing right? I'm just telling myself, every time I get rental income put the same amount from my work tax into pension. So it's like stretching that 600 profit and making it into 1400. Effectively more than 2x return.

Then I plan to invest that money into an index fund and make returns off it for the year, hopefully making good profit. 

Whatever that profit amount I get, I use some of that from my bank account to pay off the rental tax at the end of the tax year. 

So in effect I get to invest "free" cash for a while and hopefully make returns from it to pay off the rental tax.

Am I being clever or just bonkers in my mental framing 😂? 

Diesel3390

Sorry I re-read my own post and realised I may not have been clear.

So in effect my mental framing is:

- every time I get 600 in rental profit, I actually get 1000 into bank account as its gross.
- put the same 1000 from my work salary into pension to get 1.4k. It's like stretching the 600 to become 1.4k : more than double instantly.
- invest that money each month inside my pension into an index fund and hopefully make good money
- I know I can't withdraw the money but it's still inside my pension to use many years later. I'm still KEEPING the money in effect right?
- when it comes to paying tax, pay it off end of tax year but with pride that I got to effectively "leverage" and stretch that 600

Is it clever or just useless thinking 😂? 

Dazed_and_C0nfused

Diesel3390 said:

Sorry I re-read my own post and realised I may not have been clear.

So in effect my mental framing is:

- every time I get 600 in rental profit, I actually get 1000 into bank account as its gross.
- put the same 1000 from my work salary into pension to get 1.4k. It's like stretching the 600 to become 1.4k : more than double instantly.
- invest that money each month inside my pension into an index fund and hopefully make good money
- I know I can't withdraw the money but it's still inside my pension to use many years later. I'm still KEEPING the money in effect right?
- when it comes to paying tax, pay it off end of tax year but with pride that I got to effectively "leverage" and stretch that 600

Is it clever or just useless thinking 😂? 

That is impossible.

There are three main methods of getting money into a pension and the most you could ever turn £1,000 into is £1,250.

There may be separate personal tax saving for you but as far as the pension is concerned the maximum it would become is £1,250.

And that is only for relief at source contributions.

What method does your company use?

Relief at source?
Net pay?
Salary sacrifice?

Diesel3390

I mean if I put 1k of my take home pay.
So after tax. 

Wouldn't that mean if I put in 1k into pension I get 20% back immediately, and then another 20% when I file self assessment? So the 1k becomes 1.4 no? 

[Deleted User]

Diesel3390 said:

I mean if I put 1k of my take home pay.
So after tax. 

Wouldn't that mean if I put in 1k into pension I get 20% back immediately, and then another 20% when I file self assessment? So the 1k becomes 1.4 no? 

If you put £1000 into a SIPP the pension company will claim basic rate tax relief to make the gross contribution £1250 - nothing comes back to you. 

If you are a higher rate taxpayer you can claim an additional 20% relief on £1250 - £250

£1250 into your pension scheme at a net cost to you of £750.

Dazed_and_C0nfused

Diesel3390 said:

I mean if I put 1k of my take home pay.
So after tax. 

Wouldn't that mean if I put in 1k into pension I get 20% back immediately, and then another 20% when I file self assessment? So the 1k becomes 1.4 no? 

No, you've got the wrong end of the stick somewhere along the line.

If you add £1,000 to a relief at source pension like a SIPP then the pension company will add 25%, making a fund of £1,250 (the £250 being 20% of the gross contribution).

You can then claim higher rate relief and this may save you another £250 in personal income tax although the exact amount will depend on what other income you have and how much higher rate tax is due.  The higher rate relief is given by increasing the amount of your basic rate band so, in this example, an extra £1,250 can be taxed at 20% rather than 40%.

There is no situation where your £1,000 contribution ends up as a pension fund of £1,400.

sheramber

Buy you still need to pay £400 tax on the rental income. 

amanda1024

If I’m understanding correctly, possibly what you want to do is make a pension contribution of £800, which will have £200 basic rate tax relief added, and if you’ve paid enough higher rate tax you could also claim a £200 tax refund - so the cost to you would be £600, once you’ve accounted for the refund. But I may be misunderstanding 

[Deleted User]

amanda1024 said:

If I’m understanding correctly, possibly what you want to do is make a pension contribution of £800, which will have £200 basic rate tax relief added, and if you’ve paid enough higher rate tax you could also claim a £200 tax refund - so the cost to you would be £600, once you’ve accounted for the refund. But I may be misunderstanding 

You’re not! 

Diesel3390

amanda1024 said:

If I’m understanding correctly, possibly what you want to do is make a pension contribution of £800, which will have £200 basic rate tax relief added, and if you’ve paid enough higher rate tax you could also claim a £200 tax refund - so the cost to you would be £600, once you’ve accounted for the refund. But I may be misunderstanding 

Exactly. I may just be thinking about the relief in the wrong way but yes what you've stated is effectively what I'm trying to get at.

What I basically want to do is: "okay I need to pay £400 on every £1,000 I earn on rental income... what is the best way to avoid the tax legally". 

So in order to get access to £1,000 in my pension I am effectively only paying £600 in the scenario you posted, correct? In which case I'm saving £400.

So isn't that like saving on the £400 I was due on tax in the rental income?

Thanks,

CouldntResist

I'm not sure why this is so difficult. If you pay the post tax rental income into your pension then after the relief it effectively attracts no tax. Some of that relief may be outside the pension but if you have the cash you can pay that into the pension as well.

It's no more complicated than that.