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60% tax relief on pension contributions

October 7th 2009

If you earn £110,000, from 2010, you will have lost most of the personal allowance, £5,000 of it to be exact. However, by making a personal pension contribution of £10,000 you get £4,000 tax relief on that contribution and get your £5,000 personal allowance back. This means that the £5,000 is now sheltered from 40pc income tax, so you save a further £2,000. The total tax saving is therefore £6,000, or 60%.  

For people earning just above £100,000, making a pension contribution is a ‘no brainer’ particularly given that they are next in line if the Treasury comes back for another swipe at tax relief.

LOWERING INCOME BELOW £150K USING PENSION CONTRIBUTIONS
A similar approach may also pay off for those earning slightly more than £150,000 from all earnings e.g. savings, investments, interest from deposits dividend and rental income etc, the point at which higher-rate tax relief on pension contributions is capped at £20,000. Again, the rules allow payments into your pension scheme to reduce your effective income. Here’s an example comparing two employees: Bill, who earns £170,000, and Barry, who earns just £1 less in 2010/11.
 
Barry earns £169,999 and makes a pension contribution of £50,000 gross. His relevant earnings are £149,999 because he is able to offset his gross income using his pension contributions subject to the £20,000 cap. He is therefore not subject to the "anti-forestalling" rules.
 
As a result, his whole pension contribution receives full tax relief; in his case the total tax relief would amount to £22,000. Any employer contributions could also be made with no tax implications for Barry.
 
Bill earns £170,000 and makes the same pension contribution of £50,000 gross. His relevant earnings are £150,000 because he is able to offset his gross income using his pension contributions subject to the £20,000 cap. However, he is therefore subject to the anti-forestalling rules.
 
As a result, only £20,000 of his pension contribution receives full tax relief, the rest gets just 20%. In his case, the total tax relief would amount to £16,000, £6,000 less than Barry could claim.
 
Furthermore, any employer contributions made on his behalf would result in a tax charge of at least 20% (possibly 30% but this, like many things, is unclear at the moment), Therefore, a £20,000 employer contribution in addition could incur a tax charge of £4,000 or possibly £6,000.
 
Reducing relevant earnings by making a pension contribution is a particularly useful strategy for people earning between £150,000 and £170,000 bracket. However, HMRC will also look at your earnings levels in the last two tax years so you may already be caught in the net by virtue of your previous income.
 
Charitable contributions that qualify for gift aid can also serve to reduce your income below the £150,000 threshold. If Barry gave £1 to charity, he could pay £10,000 or possibly £12,000 less in tax by making a £50,000 pension contribution. Alternatively, he could ask his employer to reduce his pay by £1.
 
Equally, someone earning £200,000 could make a £30,001 contribution to charity, put £50,000 into their pension and get full tax relief on their pension contributions.
 
Important note: These examples assume that the employees had no previous ‘regular’ (that is, monthly or quarterly) contributions and were earning less than £150,000 in the previous two tax years. Figures are based on the rules in place for 2010/11 and Prosperis Ltd’s current understanding of what HMRC is up to.
 
EFFECT OF LOWERING INCOME BELOW £150,000 BY A SIMPLE REDUCTION IN SALARY
A further example would be to look at another high earner, Bob, to show how a £1 salary cut can pay huge dividends near the £150,000 threshold.
 
Imagine that Bob earns £150,000 and his employer makes a one-off payment of £30,000 into a pension on his behalf in 2010/11. His salary is over the £150,000 limit and he is, therefore, subject to a tax charge of 20pc (or possibly 30pc) on the contribution in excess of £20,000. So he pays a tax charge of £2,000 or £3,000.
 
By asking to earn £1 less, Bob could arrange not to be subject to the anti-forestalling measures and could therefore avoid this tax charge altogether.
 
The potential tax savings from earning just £1 less income make a mockery of the entire Treasury proposal although it could be a more risky strategy. HMRC has said it will clamp down on anti-avoidance measures and might see this as just that. As things stand, the Treasury will definitely succeed in adding a huge level of complication to the pension system but will probably find it makes nowhere near as much revenue as it expected.
 
It is hard to escape the conclusion that HMRC is making this up on an hourly basis.