Mitigating your bill through pension planning

THE trick with pension contributions is to understand your tax position. Looking specifically at high earners, there are two specific income thresholds, £100,000 and £150,000 to bear in mind.

PASSING £100K
Once you hit £100,000 per annum of income from all sources, you gradually lose your tax-free personal allowance, at a rate of £1 for every £2 of income over £100,000. The allowance is currently £7,475 per annum, so it is all lost once income exceeds £114,950. This creates an effective rate of income tax of 60 per cent on income between £100,000 and £114,950. This can be solved by making a pension contribution. If your income is exactly £114,950, getting £14,950 in your pension will reduce your taxable income to £100,000 and is only going to cost you £5,980 once you’ve got all the tax relief. So, it’s an easy choice. Do you want £5,980 in your pocket or £14,950 in your pension? Someone with income of £120,000 would need to pay £20,000 gross into a pension to bring taxable income down to £100,000. Some of this would attract 40 per cent tax relief and some an effective rate of 60 per cent. Overall, they would get approximately 55 per cent tax relief.

OVER £150K
50 per cent tax starts at an income of £150,000, so anyone earning over this amount can receive up to 50 per cent tax relief on any pension contributions they make. For example, someone earning £200,000 could put £50,000 into a pension, or suffer 50 per cent tax and receive £25,000 in their pocket, slightly less in fact once national insurance is paid. Given that few people will be 50 per cent taxpayers, or even 40 per cent taxpayers in retirement, this opportunity to get 50 per cent or even 60 per cent tax relief on money going into a pension and possibly only paying 20 per cent tax when money is taken out at retirement is an opportunity that is hard to turn down.

As long as you have sufficient employment income to justify the contribution level, you can put up to £50,000 per annum (the annual allowance) into a pension. Furthermore, one is able to “carry forward” unused allowances from the three previous tax years, so 2008/09, 2009/10 and 2010/11. The opportunity to carry forward from 2008/09 will be lost forever if it isn’t used up by 5 April 2012. In an example where someone had paid £30,000 per annum into a pension in each of those three previous years, they could pay in up to £110,000 in 2011/12 by using their carry forward facility and 2011/12 annual allowance.

Care needs to be taken as the calculations surrounding what has previously been paid in are not as simple as one might expect, particularly where the individual is or has been a member of a defined benefit pension scheme such as a final salary scheme. Time is of the essence – so get planning.

Jason Witcombe is a director of Evolve Financial Planning