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Paying >£40k into pension to avoid Personal Allowance tapering

Practical Issues
IsuzuIse
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Paying >£40k into pension to avoid Personal Allowance tapering

#358273

Postby IsuzuIse » November 20th, 2020, 6:33 am

I am in the fortunate position of having an income of about £155k this tax year. Each year I put £40k into my pension fund. This leaves me with a taxable income of £115k. The personal allowance taper means that I'll be paying an effective tax rate of 60% on the £15k over £100k.

As I understand it, it's legal for me to pay >£40k into my pension fund, I just don't get tax relief on the money and will need to pay an annual allowance charge of 40%. With this in mind, does it make sense for me to pay £55k into my pension instead of £40k? On the face of it it appears that I would then pay £6k in tax rather than £9k on the income over £100k, making me £3k better off. I don't need the money right away, so I'm fine with it going into my pension fund rather than my bank account.

Any advice or thoughts very welcome.

Urbandreamer
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Re: Paying >£40k into pension to avoid Personal Allowance tapering

#358279

Postby Urbandreamer » November 20th, 2020, 7:12 am

I understand that the taper threshold has been moved. Something to do with NHS staffing probably, though it's not limited to those who have or are contributing to a NHS pension.

https://www.gov.uk/government/publicati ... april-2020

You probably would need professional advice if your adjusted income was above the new threshold.

Gengulphus
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Re: Paying >£40k into pension to avoid Personal Allowance tapering

#358296

Postby Gengulphus » November 20th, 2020, 8:57 am

IsuzuIse wrote:I am in the fortunate position of having an income of about £155k this tax year. Each year I put £40k into my pension fund. This leaves me with a taxable income of £115k. The personal allowance taper means that I'll be paying an effective tax rate of 60% on the £15k over £100k.

As I understand it, it's legal for me to pay >£40k into my pension fund, I just don't get tax relief on the money and will need to pay an annual allowance charge of 40%. With this in mind, does it make sense for me to pay £55k into my pension instead of £40k? On the face of it it appears that I would then pay £6k in tax rather than £9k on the income over £100k, making me £3k better off. I don't need the money right away, so I'm fine with it going into my pension fund rather than my bank account.

Any advice or thoughts very welcome.

I'm not familiar enough with the annual allowance charge to be able to comment on what you're thinking of, but just to offer a different approach: if you were to donate £12k to charities under Gift Aid, the grossed-up-by-basic-rate-tax amount of £15k would be added to your basic-rate band and to the £100k limit on taxable income before the personal allowance starts to be tapered. I.e. it would act on the main Income Tax calculation like a gross pension contribution of £15k, but without triggering an annual allowance charge. That would save you a total of £6k in tax compared with only making your normal £40k pension contribution:

Tax calculation with pension contribution, but not charity donation
Adjusted net income = £155k - £40k gross pension contribution = £115k
Personal Allowance = £12.5k - (excess of adjusted net income over £100k)/2 = £5k
Expanded basic-rate band = £37.5k + £40k gross pension contribution = £77.5k
Income allocation is £5k to Personal Allowance, £77.5k to expanded basic-rate band, remaining £72.5k to higher-rate band
Tax = 20% * £77.5k + 40% * £72.5k = £44.5k

Tax calculation with both pension contribution and charity donation
Adjusted net income = £155k - £40k gross pension contribution - 1.25 * (Gift Aided donation) = £100k
Personal Allowance = £12.5k - (excess of adjusted net income over £100k)/2 = £12.5k
Expanded basic-rate band = £37.5k + £40k gross pension contribution + 1.25 * (Gift Aided donation) = £92.5k
Income allocation is £12.5k to Personal Allowance, £92.5k to expanded basic-rate band, remaining £50k to higher-rate band
Tax = 20% * £92.5k + 40% * £50k = £38.5k

So that's twice the tax saving that you've calculated (*) for making an extra £15k pension contribution, and the charities benefit by your £12k donation + £3k reclaimed Gift Aid = £15k, while it costs your bank account the £12k donation - £6k tax saving = £6k. I.e. the charities benefit by 2.5 times what it costs you now.

The drawback is that it depends on you not needing the money at all, rather than just not needing it at all. And it does depend on there being charities you think are worth supporting to that extent. Both of those are of course things I don't know about you, so I'm not recommending that you should definitely do it - just that it's an option that might be worth considering.

(*) Just to make certain it's clear: I'm not knowledgable enough to know whether your calculation is correct or not.

Gengulphus

Gengulphus
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Re: Paying >£40k into pension to avoid Personal Allowance tapering

#358337

Postby Gengulphus » November 20th, 2020, 10:37 am

I see that I wrote a bit of nonsense and failed to spot it on previewing:

Gengulphus wrote:The drawback is that it depends on you not needing the money at all, rather than just not needing it at all.

What I intended to write was "The drawback is that it depends on you not needing the money at all, rather than just not needing it right away.", but clearly something went wrong between my brain and my fingers!

Gengulphus

TedSwippet
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Re: Paying >£40k into pension to avoid Personal Allowance tapering

#358432

Postby TedSwippet » November 20th, 2020, 1:48 pm

IsuzuIse wrote:As I understand it, it's legal for me to pay >£40k into my pension fund, I just don't get tax relief on the money and will need to pay an annual allowance charge of 40%.

The mechanics of this is that your pension payment is that your excess pension payments above the pension annual allowance are added back into your salary for tax purposes. On the numbers given then, you would still be in the 60% band, and with a £9k tax bill. You might be able to use 'scheme pays' to pay that £9k from inside the pension itself (which of course reduces the amount in the pension by £9k). Otherwise, you have to find this money from elsewhere.

IsuzuIse wrote:With this in mind, does it make sense for me to pay £55k into my pension instead of £40k? On the face of it it appears that I would then pay £6k in tax rather than £9k on the income over £100k, making me £3k better off.

Are you forgetting that this pension money -- or what remains of it after 'scheme pays' -- will taxable when you withdraw it? If you pay tax on contributions and then tax again on withdrawals, this is pure double-tax. Overall, this looks to me like a bad plan.

Urbandreamer wrote:I understand that the taper threshold has been moved. Something to do with NHS staffing probably, though it's not limited to those who have or are contributing to a NHS pension.

https://www.gov.uk/government/publicati ... april-2020

This relates to changes in the tapered pension annual allowance. The OP is asking about the tapered annual personal tax-free allowance, which hasn't changed since its introduction a decade ago.

Adamski
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Re: Paying >£40k into pension to avoid Personal Allowance tapering

#358438

Postby Adamski » November 20th, 2020, 2:16 pm

I'd you pay over the 40k you get no tax relief on contributions over the cap and face an additional tax charge, the annual allowance charge.

The other option is top up their pension and ISA of your partner and\or children if applicable. Add up all the allowances in a family, quite generous.

pochisoldi
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Re: Paying >£40k into pension to avoid Personal Allowance tapering

#358673

Postby pochisoldi » November 21st, 2020, 10:03 am

Adamski wrote:I'd you pay over the 40k you get no tax relief on contributions over the cap and face an additional tax charge, the annual allowance charge.

The other option is top up their pension and ISA of your partner and\or children if applicable. Add up all the allowances in a family, quite generous.



The OP's objective is to avoid tapering of their personal allowance.
Paying money into someone else's pension, or giving someone money to put in their ISA will not do this as it does nothing to change the OP's current income tax situation (, but could make a difference for IHT for money handed to a non-spouse if the OP dies within 7 years).


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