FREE money in your pension PLUS 7.2% more in your pocket ?????

langtone

I believe ( please correct me if wrong ) that :

If you are earning less in 2008-09 than 2007-08 then this years Tax Credits are based on this years earnings.

Put £1000 into a pension and you get an extra £370 tax credit. ( You are deemed to have had £1000 less taxable earnings and credits reduce by 37% with income )

Not only that but 2009-10 tax credits will also be up by £370 as they will be based on 2008-09 unless you will earn less that year.

So put £ 1000 in a pension (before tax), get £740 back in your pocket, tax free, over 2 years. Take it as income and only get £690.

So you turn £1000 ( before tax ) into £1000 in your pension and still get £740

meester

The tax credit withdrawal rate has gone up to 39%. So it's actually slightly better than you say. And yes, you're correct about the pension payment coming off your income for tax credit purposes.

The issue is that few recipients of tax credits are contributing to any pension at all, quite possibly because they can't afford to.

Tax credits are rather bizarre in their administration, as people get showered with money, the calculation of which they have no idea how to compute, and then suddenly find out a year later that they are not entitled to it. As a result you can earn up to £25,000 more in one year than the previous year and still be entitled to tax credits. To be perfectly frank, this is a total p iss take, because a £25k increase in income wipes out £9,750 worth of tax credits at 39% (assuming you are entitled to that much in the first place)

Tax credits are supposed to be calculated on the last tax year's income. But if your 'income' has fallen you can contact HMRC straight away and get your tax credits increased. I'm not sure how they would treat an increased pension payment, but according to their site, pension payments are taken off your income. I would suggest you call HMRC and say that your pension payment has been increased substantially, does that mean you can get more tax credits.

I actually went some of the way down this path before, though I didn't follow through due to the fact that it's asking for trouble, and I don't really want HMRC attention (due to IR35 status).

But there doesn't seem otherwise any reason not to exploit the Labour benefits culture as much as you can, and do the following:

Year 1, let's say you earned £70k. No tax credit entitlement.
Year 2, inform HMRC you are now making £64k gross pension payment, hence income has dropped to £6k. Cost of pension payment is roughly £45,000, net of tax. For a married couple with two kids and one income, the tax credits come to £1,800 + £1,770 + £735 + £545 + £2085 + £2085 = £9020
Year 3, Pay £39,001 gross pension (£23400 net). Income increases by £24,999. No need to inform HMRC. Tax credits hence again £9020.

Hence after 3 years, you have £103,000 in your pension. You have lost out on £45,000 + £23,400 = £68,400 of net income. But you have received £18,000 in tax credits. So the net cost is £50,0000. For which you have received £103,000 of pension. I.e. the tax relief is well over 50%.

The other way of looking at it is that £9,020 (or whatever your personal circumstances will earn you) is free money.

A simple bit of maths shows, that, given that tax credits are withdrawn at 39% and basic rate of tax is 20% (80% retained income), then:

assuming t is your tax credit award, then
y1, you lose t/.39 * .8, but gain t
y2, you gain t

That is the lost income is t + t - 2.0513t = -0.0513t

And in addition, you GAIN in your pension t/.39

Hence
pension gain = t/.39
income gain = -0.0513t

So in terms of the amount gained to your pension relative to the amount lost from your salary, it is FIFTY times gearing (this also follows intuitively, simply because you are getting 2 * 39% relief = 78%, while paying for the pension, 80% of the cost).

In other words, you pay 2%, and HMRC grosses up by NINETY EIGHT PER CENT

There are two limits on the relief: the £25k maximum income differential, and the size of your tax credit payout. 39% of £25,000 is £9,750, which is probably more than your tax credit payout.

Since tax credits are withdrawn starting from £6,420, assuming your income is anywhere between £6,420 and (£6,420 + your tax credit award / 39%), you will get the above mentioned 50 times effective match on the pension.

So for one income, two kids, no child care, that is £9,020 award, meaning 9020/.39 + 6420 = £29,548. Anyone earning between £6,420 and £29,548 would get 50* the amount of net income they sacrificie over two years.

On the amount between £29,548 and £40k (roughly the higher rate allowance), you are only getting 20% tax relief, and above that 40% relief. The blended rate therefore will not be as attractive if you earn much over the tax credit threshold.


I would say though, that if you earn say £26,420, it's a no-brainer to pay £20k into a pension (which is only £16k net), and get £7.8k back immediately and £7.8k back in year 2. Even if you have to borrow to do so, it makes sense.

(PS. I discussed some elements of pension tax credit planning before:

http://forums.moneysavingexpert.com/showthread.html?t=738223
Lots of people whined. I ignored them.


Unfortunately I have not ended up exploiting the tax credit system yet. The concept appeals to me, but the execution for me would be a little hard. But I would recommend that anyone whose affairs are more straightforward than mine do so. If you're just a PAYE employee on £25-£30k, and you pay all your salary into a pension, you'll get half of it back in tax credits straight away, and you'll have a massive boost to your pension.)

Not sure what happens in year 3? Do they ask you about your previous year's earnings every year? If so, all you have to do in year 3 is inform that you are making a £20k pension contribution again, so your income is going to be £6,420, thanks very much.

Rinse and repeat, after 10 years, you've got £100k of pension (plus growth of course) at a cost of £5k.

averageguy11

ouch i can c what u mean from tht thread meester...i trade thru a ltd company and wil hav an increase in CT ths year...no problems with husband/wife tax situ though....i thought the 25k differential on earnings was a one off though?

Andy_L

I just played around with entitledto.co.uk & it was only offering £2.5k tax credits on a £26k salary & £20k pension contributions. What am I missing?

meester

Andy_L wrote: »

I just played around with entitledto.co.uk & it was only offering £2.5k tax credits on a £26k salary & £20k pension contributions. What am I missing?

No idea.

I wouldn't pay much attention to those sites, the actual rules are on www.hmrc.gov.uk

Do you have children? This only makes sense if you have kids (= high tax credit entitlement).

Andy_L

That'll be it, 2 kids ups it to ~£9k

purch

Of course the whole strategy (or at least 1/2 of it) goes up in smoke if HMRC decide to remove the £25,000 income increase disregard for the following years TC's

meester

purch wrote: »

Of course the whole strategy (or at least 1/2 of it) goes up in smoke if HMRC decide to remove the £25,000 income increase disregard for the following years TC's

Hardly.

Let's not forget that y1, you are paying in to your pension with 59% relief.

Still good.

Besides which Gordon Brown has just got HORRIBLE publicity for stealing from the poor, it's unlikely that they will change the rules given that they brought in the £25k rule because of people spending all their tax credits and then having to pay them back.

purch

Hardly

:eek:

OOppps sorry.........my bad (ran out of fingers :rolleyes: )

Of course the whole strategy (or at least 41% of it) goes up in smoke if HMRC decide to remove the £25,000 income increase disregard for the following years TC's

Still good

Gooder than good 59% free money from HM Gov is not to be sniffed at....I'll have to devise some cunning plan to qualify for TC's

averageguy11

I thought the 25k salary differential was just a one off...u saying its every year now?

purch

http://www.hmrc.gov.uk/taxcredits/changes-in-income.htm