Avoiding higher rate tax

concernedpharmacist

I would like to check my understanding of tax and pensions using a real life example:

Simon receives £50,000 of pension income each year   (£26K p.a. DB and £2K p.c.m. drawdown of DC).

This brings him very close to the 40% tax threshold.

He has already triggered the MPAA.

Simon has potential to earn up to £10,000 per year through self-employment.  This would normally be subject to 40% tax.

However,  if Simon  contributes £8K p.a. of this income to a SIPP (£10k with tax relief) he can effectively avoid any 40% tax rate as the  40%:threshold will be raised by £10k because of the pension contribution. This will be adjusted when Simon submits his self-assessment tax  return.

Is this second paragraph correct? 

Are there any flaws in my understanding?

Thanks in advance for your help.

Grumpy_chap

concernedpharmacist said:

I would like to check my understanding of tax and pensions using a real life example:

Simon receives £50,000 of pension income each year   (£26K p.a. DB and £2K p.c.m. drawdown of DC).

This brings him very close to the 40% tax threshold.

He has already triggered the MPAA.

Simon has potential to earn up to £10,000 per year through self-employment.  This would normally be subject to 40% tax.

However,  if Simon  contributes £8K p.a. of this income to a SIPP (£10k with tax relief) he can effectively avoid any 40% tax rate as the  40%:threshold will be raised by £10k because of the pension contribution. This will be adjusted when Simon submits his self-assessment tax  return.

Is this second paragraph correct? 

Are there any flaws in my understanding?

Thanks in advance for your help.

First clarification.
Has Simon already taken the full TFLS, or is any (25% ?) of the £2k per month DC drawdown tax free?

Isthisforreal99

Being already that close to the HR threshold means that there is a possibility that the 'new' pension contributed to will be taxed at 40% when accessed, the only benefit being the tax free lump sum.

concernedpharmacist

The £2k p.c.m drawdown income is all subject to 20% tax. Tax free lump sum already taken.
(The personal allowance is applied to the DB pension)

Grumpy_chap

When considering the £10k of self employment, I assume this will be as Sole-Trader, not own Ltd Co.

I understand that a Sole-Trader would need to make personal pension contributions, not employer contributions.

Personal SIPP contributions are usually paid from taxed income and then the SIPP claims back the tax-relief uplift which is added to the pension fund.  When £8k is paid into the pension, the SIPP grosses this up to £10k in the fund.  That does not avoid paying the tax in the first place.  That is how it would work for an employee on PAYE.

If the self-employment is via own Ltd Co., then the £10k can be made as employer contributions to the pension and, hence, avoid the tax being incurred in the first place.

I am not aware that a Sole-Trader can make employer pension contributions.

I hope that helps and I am sure someone will be along shortly to clarify and correct me if my understanding with regard to Sole-Trader making employer contributions is incorrect.

concernedpharmacist

Isthisforreal: The "new pension" would only be accessed at a time in the future when the £2k pcm DC pension pot had depleted. So shouldn't avoid exceeding HR threshold at that time.

GrumpyChap: Simon is a sole trader, I agree the £8k would gross up to £10k. But I also believe that the HR  tax threshold would be raised by £10K as a consequence of the contribution. Is this correct?

Dazed_and_C0nfused

Grumpy_chap said:

When considering the £10k of self employment, I assume this will be as Sole-Trader, not own Ltd Co.

I understand that a Sole-Trader would need to make personal pension contributions, not employer contributions.

Personal SIPP contributions are usually paid from taxed income and then the SIPP claims back the tax-relief uplift which is added to the pension fund.  When £8k is paid into the pension, the SIPP grosses this up to £10k in the fund.  That does not avoid paying the tax in the first place.  That is how it would work for an employee on PAYE.

If the self-employment is via own Ltd Co., then the £10k can be made as employer contributions to the pension and, hence, avoid the tax being incurred in the first place.

I am not aware that a Sole-Trader can make employer pension contributions.

I hope that helps and I am sure someone will be along shortly to clarify and correct me if my understanding with regard to Sole-Trader making employer contributions is incorrect.

You are correct as, in the scenario the op outlined, there is no employer who could make contributions.

Someone who is self employed would normally have to make relief at source contributions and the gross contribution would increase the basic rate band.

Whether the op can contribute £10k is a different matter.  They have referred to the potential to "earn" upto £10k.  If they mean they had profits of at least £10k then from what they have posted they could pay £10k gross (£8k net plus £2k basic rate relief).

If profits were only say £8k then they could only contribute £8k gross (£6.4k net plus £1.6k in basic rate relief).

Mutton_Geoff

concernedpharmacist said:

The £2k p.c.m drawdown income is all subject to 20% tax. Tax free lump sum already taken.
(The personal allowance is applied to the DB pension)

What happens when his state pension starts? This will push him into the higher rate tax bracket.

Even without relevant earnings he can pay £3,600 into his SIPP (£2,880 contribution earning £720 relief, total £3,600).

concernedpharmacist

Mutton_Geoff said:

concernedpharmacist said:

The £2k p.c.m drawdown income is all subject to 20% tax. Tax free lump sum already taken.
(The personal allowance is applied to the DB pension)

What happens when his state pension starts? This will push him into the higher rate tax bracket.

Even without relevant earnings he can pay £3,600 into his SIPP (£2,880 contribution earning £720 relief, total £3,600).

By the time the state pension comes the DC pension currently giving 2k per month will have depleted. 

concernedpharmacist

Dazed_and_C0nfused said:

Grumpy_chap said:

When considering the £10k of self employment, I assume this will be as Sole-Trader, not own Ltd Co.

I understand that a Sole-Trader would need to make personal pension contributions, not employer contributions.

Personal SIPP contributions are usually paid from taxed income and then the SIPP claims back the tax-relief uplift which is added to the pension fund.  When £8k is paid into the pension, the SIPP grosses this up to £10k in the fund.  That does not avoid paying the tax in the first place.  That is how it would work for an employee on PAYE.

If the self-employment is via own Ltd Co., then the £10k can be made as employer contributions to the pension and, hence, avoid the tax being incurred in the first place.

I am not aware that a Sole-Trader can make employer pension contributions.

I hope that helps and I am sure someone will be along shortly to clarify and correct me if my understanding with regard to Sole-Trader making employer contributions is incorrect.

You are correct as, in the scenario the op outlined, there is no employer who could make contributions.

Someone who is self employed would normally have to make relief at source contributions and the gross contribution would increase the basic rate band.

Whether the op can contribute £10k is a different matter.  They have referred to the potential to "earn" upto £10k.  If they mean they had profits of at least £10k then from what they have posted they could pay £10k gross (£8k net plus £2k basic rate relief).

If profits were only say £8k then they could only contribute £8k gross (£6.4k net plus £1.6k in basic rate relief).

For the purpose of this discussion assume that Simon earns the full £10K profit. Would it then be the case that when the self assessment return is completed giving details of £10k earned and £10 pension contribution, HR tax will be avoided?

Isthisforreal99

concernedpharmacist said:

Dazed_and_C0nfused said:

Grumpy_chap said:

When considering the £10k of self employment, I assume this will be as Sole-Trader, not own Ltd Co.

I understand that a Sole-Trader would need to make personal pension contributions, not employer contributions.

Personal SIPP contributions are usually paid from taxed income and then the SIPP claims back the tax-relief uplift which is added to the pension fund.  When £8k is paid into the pension, the SIPP grosses this up to £10k in the fund.  That does not avoid paying the tax in the first place.  That is how it would work for an employee on PAYE.

If the self-employment is via own Ltd Co., then the £10k can be made as employer contributions to the pension and, hence, avoid the tax being incurred in the first place.

I am not aware that a Sole-Trader can make employer pension contributions.

I hope that helps and I am sure someone will be along shortly to clarify and correct me if my understanding with regard to Sole-Trader making employer contributions is incorrect.

You are correct as, in the scenario the op outlined, there is no employer who could make contributions.

Someone who is self employed would normally have to make relief at source contributions and the gross contribution would increase the basic rate band.

Whether the op can contribute £10k is a different matter.  They have referred to the potential to "earn" upto £10k.  If they mean they had profits of at least £10k then from what they have posted they could pay £10k gross (£8k net plus £2k basic rate relief).

If profits were only say £8k then they could only contribute £8k gross (£6.4k net plus £1.6k in basic rate relief).

For the purpose of this discussion assume that Simon earns the full £10K profit. Would it then be the case that when the self assessment return is completed giving details of £10k earned and £10 pension contribution, HR tax will be avoided?

Yes, £8k net contribution will eliminate any HR liability in this scenario.