The UK government has some arguably draconian tax rules for people who earn over £100,000pa. For every £2 pounds of earnings over £100,000 the amount of personal allowance is reduced by £1.
So, for example Jane who earns £110,000 has their 2019/20 personal allowance reduced by £5,000 (£10,000/£2 = £5,000). This has the effect of reducing the personal allowance from £12,500 to £7,500. As the person is already a higher rate taxpayer paying 40% tax on these earning this personal allowance reduction amounts to a 60% tax charge.
There is a way to reduce your tax bill. By making a pension contribution.
With the example of Jane if she wrote a cheque for £8,000 to her pension, the pension company would then gross this up to £10,000 by claiming £2,000 tax relief from HMRC. This has the effect of reducing Jane’s annual net income by £10,000 to £100,000. If Jane did this, it would restore her full personal allowance of £12,500. This is in effect a £4,000 tax saving. She pays 20% less tax on the £10,000 she has earned over £100,000 and also gains £2,000 tax relief from HMRC to her pension fund.
And it gets better as Jane is a higher rate taxpayer, she can claim higher rate tax relief on her pension contribution. If Jane declares her £10,000 gross pension payment on her tax return, she gets a further £2,000 relief from HMRC and this is paid back by an adjustment to her tax code. So, in effect she has only had to pay out £6,000.
The added bonus is that this helps to fund Jane’s retirement. The pension payment is invested in a tax-free fund until Jane wants to draw the funds at retirement.
If you have any questions on how to start a pension please, don’t hesitate to get in touch!
** Investment values and income from them can go down as well as up, investors may get back less than their original investment. Companion Financial Planning LLP is authorised and regulated by the Financial Conduct Authority; registration number 705850. **