Reduce tax paid by putting to pension

penners324

Are they self employed or a director of that company?

If so switching to being paid dividends would reduce his tax bill significantly 

Dazed_and_C0nfused

penners324 said:

Are they self employed or a director of that company?

If so switching to being paid dividends would reduce his tax bill significantly 

I really don't think we know enough about the op's friend to know this.

It's a might reduce not a would reduce.

artyboy

OK, so very simplistically (ignoring NI and other fringe stuff), they have £40k of income they are paying 40% tax on, therefore that income slice represents £24k of take home pay.

If that £40k was put into a pension, it would be... £40k in the pension. So they gain £16k in terms of tax they don't have to pay. But they give up £24k of take home pay in the process.

Incidentally, if the OP's friend is shocked at the amount of tax they are paying, just wait till they get a raise that takes them into the 62% effective tax band...

Alexland

artyboy said:

If that £40k was put into a pension, it would be... £40k in the pension. So they gain £16k in terms of tax they don't have to pay. But they give up £24k of take home pay in the process.

It's worth remembering that some proportion of the money put into the pension would likely be taxed on withdrawal so the pension contribution should be seen as a way of deferring income until it can be drawn at (hopefully) lower rates of tax in retirement.

artyboy

Alexland said:

artyboy said:

If that £40k was put into a pension, it would be... £40k in the pension. So they gain £16k in terms of tax they don't have to pay. But they give up £24k of take home pay in the process.

It's worth remembering that some proportion of the money put into the pension would likely be taxed on withdrawal so the pension contribution should be seen as a way of deferring income until it can be drawn at (hopefully) lower rates of tax in retirement.

Yes, I was deliberately simplifying the example here. We could also get into the fact that any investment growth would also be tax free/deferred, but I wanted to focus on the core point of opportunity cost re take home pay...

tracyk23

AlanP_2 said:

Does this friend run their own business?

If they do, are they a Ltd Company or sole trader / partnership?


Self employed pension contributions have other wrinkles which can be explored e.g. if Ltd company pension contributions can be made by the company and not the individual with potentially higher tax savings.

They are a director of a Ltd company yes.

AlanP_2

tracyk23 said:

AlanP_2 said:

Does this friend run their own business?

If they do, are they a Ltd Company or sole trader / partnership?


Self employed pension contributions have other wrinkles which can be explored e.g. if Ltd company pension contributions can be made by the company and not the individual with potentially higher tax savings.

They are a director of a Ltd company yes.

Thanks.

I'll now bow out as I am not overly familiar with the nuances of that and pensions but am aware, from comments on here, that taking Dividends and making Employer Pension Contributions is the route that most people in that situation follow.

I'm sure someone with relevant experience / knowledge can post more info.

Marcon

tracyk23 said:

AlanP_2 said:

tracyk23 said:

Tucosalamanca said:

If only it were that simple.... We'd stop paying tax and put it all in pensions if this was possible

I actually did think it was that simple - I thought it was the only legitimate way these days to reduce tax.

Making additional pension contributions would reduce the overall income tax bill at the end of the day but whether it would affect take home pay would depend on how the contributions were paid.

If they were deducted from salary by the employer and paid into workplace scheme then take home would reduce by the amount contributed and any relevant tax / NI adjustments that occur as a result.

If the contributions were made to a non-workplace scheme e.g. a SIPP from take home pay then income tax due would possibly be recalculated but take home pay would not be affected as it wouldn't go through payroll.

Is your friend looking to reduce his overall tax bill or looking to maximise take take home pay or looking to increase his pension provision?

Clarity on the objective can help us to steer them in the right direction.

Thanks for this - I shall clarify if he can drop some take home pay. I was running the payroll for him and was astounded at the amount of tax he was paying and thought he could reduce it by putting into some kind of pension. Not sure increasing pension is his main motivation as he is only paying the minimum just now. 

I appreciate you are well intentioned, but it might be better to let your friend do his own research? That way if he doesn't like the outcome of his own actions he can't point the finger at you!

If he's earning £90K and only paying the minimum into his pension, he certainly does need a wake up call if he hopes to maintain any sort of decent standard of living when he gets to retirement, whatever his age now. Paying contributions by salary sacrifice will save him employee's NI and save the company employer's NI as well as giving him tax relief at his marginal rate on those contributions - but without knowing what his objectives are, it's impossible to know whether that is something he'd wish to do. There are other tax efficient ways of investing, so suggest he explores those - and perhaps gets some proper advice from an independent financial adviser.