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 donationAdjusted 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 donationAdjusted 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