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I Don’t Believe It…

Author Image Les Cameron Head of Technical
7 minutes read
Last updated on 24th Dec 2019

I’m writing this tax year-end article on pensions on the cusp of a general election. Is it time to dust off the old ‘could pension tax relief be under threat’ line?

A quick spin around the main parties’ manifestos and nothing to see to suggest tax relief is under threat. Reform of the net pay anomaly and perhaps something with the tapered annual allowance, but tax relief as we know and love (?) it seems here to stay.

Which clients do you need to focus on at this busy time, running up to the end of the tax year?

Tax relief is available at an individual’s highest marginal rate on contributions up to 100% of relevant earnings (or £3,600 if higher). Tax relief is available only on individual or third-party pension contributions paid before the member reaches age 75. And tax relief is granted in the tax year the pension contribution is actually paid.

A quick reminder that Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. NSND income includes employment income, profits from self-employment (including sole traders and partnerships), rental profits and pension income (including the state pension). Similarly, from 6 April 2019, Welsh taxpayers have paid the Welsh Rate of Income Tax (CRIT (C for Cymru)) on NSND income. 

Other tax and deductions such as corporation tax, dividends, savings income and National Insurance contributions will remain based on UK rules. This could mean the amount of income tax relief that can be claimed on pension contributions by Scottish and UK taxpayers may not be the same. For more information on SRIT and how this works in practice, please visit our facts page. For more information on CRIT and how this works in practice, please visit our facts page.

Individuals who fall into one of the tax traps

Higher-rate tax

Max has relevant earnings of £52,000 (no other income), so has £2,000 subject to higher-rate tax. Using the UK rate of 40%, this means from that £2,000 he takes home £1,200 (National Insurance contributions ignored). 

If instead he made a net pension contribution of £1,600 (assuming this is paid to a Relief At Source scheme, it will be grossed up to £2,000 in the pension), and completes his self-assessment tax return to claim a further 20% on the £2,000 contribution, the net cost to Max is £1,200, but he has £2,000 invested in his pension.

For clients in this scenario, you need to identify earnings in higher tax bands. If Max wanted to pay more, eg £5,000, there would be no higher-rate tax relief on £3,000 of this contribution.

However, you could maximise tax relief, by splitting large contributions across tax years where there are insufficient earnings in marginal bands this year to achieve full marginal rate relief. With the caveat that tax relief rules may change before further contributions are paid.

Child benefit tax charge

The high-income child benefit tax charge (HICBC) applies to those who have adjusted net income over £50,000 and are (or their partner is) receiving child benefit. Reducing adjusted net income can reduce the impact.

Do you need a reminder on how to calculate adjusted net income?

For clients in this scenario, you need to calculate adjusted net income, identify the excess over £50,000 limit, calculate the pension contribution required to reduce adjusted net income to £50,000, and make the personal pension contribution in the tax year in which the HICBC would be due. Tax relief is over 60% if you have three children!

Loss of personal allowance

Noel received a generous winter bonus of £25,000, but with salary of £100,000 this means he’ll lose all his personal allowance. You lose £1 personal allowance for each £2 of adjusted net income (ANI) above £100,000. He doesn’t need his bonus and wants to invest it. Can he avoid losing personal allowance?

A Relief At Source (RAS) pension contribution of £20,000 net (£25,000 gross) reduces his ANI from £125,000 to £100,000, regaining the full personal allowance. The effective rate of tax relief on this contribution would be 60%.

For clients in a similar situation, you need to identify total income for personal allowance purposes, ie adjusted net income, calculate excess over £100,000 limit, calculate pension contribution required to reduce adjusted net income to £100,000, and make the personal pension contribution in the tax year in which the personal allowance is lost.

Individuals with gains in higher rate

Bond gains – where does their slice fall?

Chargeable gains on investment bonds are included in taxable income calculations. Broadly, the gain is divided by the amount of years the bond has been held, to determine the ‘slice’.

The slice is then added to the top of the individual’s income to assess any tax. This means that ‘income’ = total income + dividends + bond slice + capital gains. Remember, it is the full gain that is taken into account in ANI (not the ‘slice’).

For onshore bonds, if the slice is in the basic-rate tax band, then no further tax is paid (as the bond is assumed to have paid basic-rate tax within the fund). If the slice falls fully in the higher-rate band, a further 20% tax is due, with some top slicing potentially available now. Within the additional-rate band, a further 25% is payable. The amount of tax on the slice is multiplied by the complete number of plan years the bond is held, to get the total tax payable.

Paying personal pension contributions extends the basic and higher-rate tax bands, which gives more room for the slice to fit into the basic (or higher)-rate tax band.

For clients affected, identify earnings in higher-rate tax bands, calculate bond gain ‘slice’, calculate contribution needed to move some or all of slice into lower tax band, and make the personal pension contribution in the tax year in which the bond gain is taxed.

Tax saved can be higher than contribution made!

Capital gains

A capital gain is taxed at 10% for non- and basic-rate taxpayers, and 20% for higher and additional-rate taxpayers. When the gain is calculated, it is added to the top of an individual’s income after all other income and any slice on bond gains. The part of the gain, if any, in the basic-rate tax band is taxed at 10% and the balance at 20%.

As mentioned above, paying personal pension contributions extends the basic and higher-rate tax bands, and in this case would allow more room for the gain to fit into the basic-rate tax band.

For clients affected, again identify earnings in higher-rate tax bands, calculate taxable gain, calculate contribution needed to move some or all of the gain into the basic-rate tax band, and make the personal pension contribution in the tax year in which the capital gain is taxed.

Getting higher-rate CGT relief means 30% tax relief – more than the tax on the gain!

You can see worked examples of these tax-planning angles in our knowledge centre, and they work the same with net pay arrangements too.

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Individuals with a tapered annual allowance

There have been calls to scrap the tapered annual allowance, but it’s not gone yet. Reform appears to be on the political radar, though. You may know of a client who is likely to have a tapered annual allowance for the 2019/20 tax year. If that’s the case, now’s the time to review their numbers. Income levels should be clearer, allowing you a chance to check the threshold income sums. If this exceeds £110,000, you need to go on to calculate adjusted income. This is different from the ANI calculations talked about earlier. Adjusted income is a term relating only to annual allowance. If this also exceeds £150,000, then a reduced annual allowance applies. The member loses £1 of annual allowance for every £2 above the £150,000 adjusted income limit.

It is possible to make a member’s pension contribution, either by net pay or Relief At Source methods, which will reduce the threshold income amount. If you can get this down to £110,000 or below, then this restores the full amount of the standard AA for this tax year (as you need to breach both threshold and adjusted income to have a tapered annual allowance).

I have seen a case where a contribution lower than £100 restored £30,000 of annual allowance!

It’s tax relief Jim, and still as we know it

If someone has money to invest, they should put it in the place that has the most benefit for them. So, with tax relief as we know it still here, and tax-free cash on exit, the pension will be a good place for many to be investing. 

So, it’s tax year-end and the traditional pension season. No need to ‘fill your boots’ before tax relief disappears. But shouldn’t you fill them, as it’s currently one of the most sensible places to be?

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