Tax liability reduction
Discussion
After being raped by the taxman last year I am looking to mitigate my tax liabilities this year.
Can someone "official" confirm my thinking.
Say I earn £120k this year.
This means I would lose all my tax free allowance and have pay tax at 40% on the 2012/2013 tax free allowance of approx £9000
I would basically be paying an effective tax rate of 60% on the £100k-£118k range, so government would collect about £11.4k in tax v my £8.6k take home on the last £20k i earned(thieving b
ds!)
If i were to dump £20k in a pension before April 2013, I believe that HMRC would have to
- Add 20% to my pension contribution (£4k) which would get paid directly into my pension.
- Refund me a further 20% of my pension contribution as a higher rate tax payer (£4k) which would get paid to me through a tax rebate
- Refund me the 40% tax on the £9000 tax allowance that i would now have back as I earned under £100k (£3.6k)which would get paid to me through a tax rebate
This would leave me £7.6k of savings and I would have a £24k boost to my pension.
Is this the way it would work? Any of my calculations or assumptions wrong?
Can someone "official" confirm my thinking.
Say I earn £120k this year.
This means I would lose all my tax free allowance and have pay tax at 40% on the 2012/2013 tax free allowance of approx £9000
I would basically be paying an effective tax rate of 60% on the £100k-£118k range, so government would collect about £11.4k in tax v my £8.6k take home on the last £20k i earned(thieving b
ds!)If i were to dump £20k in a pension before April 2013, I believe that HMRC would have to
- Add 20% to my pension contribution (£4k) which would get paid directly into my pension.
- Refund me a further 20% of my pension contribution as a higher rate tax payer (£4k) which would get paid to me through a tax rebate
- Refund me the 40% tax on the £9000 tax allowance that i would now have back as I earned under £100k (£3.6k)which would get paid to me through a tax rebate
This would leave me £7.6k of savings and I would have a £24k boost to my pension.
Is this the way it would work? Any of my calculations or assumptions wrong?
I know what you mean - I find the 60% marginal tax rate between £100,000 and (for 2012/13) £116,210 particularly egregious.
I think you're almost correct, although it looks like you're double counting some basic rate tax relief. If your gross earnings are £120k then you need to reduce these gross earnings to £100k. By paying £20k (gross) into your pension you will save £11,242 (i.e. 60% x £16,210 + 40% x £3,790). So a £20k input into your pension ends up costing you just £8,758.
The actual amount you'd need to pay in depends on how you contribute to your pension - e.g. are you paying gross from company payroll, or are you paying net of basic rate tax into a personal pension?
If you're paying gross into a company pension via a payroll deduction then simply have £20k deducted - even better is if you can "sacrifice" the salary so that you and your employer save NI too.
If you're paying net of basic into a personal pension then the maths is a little more convoluted but it amounts to the same thing. Basically, the insurer claims back basic rate tax of 20% so you would need to send a cheque to them for £16k. The insurer grosses this up to £20k. You would then need to do a tax return to reclaim the remainder of the 40% relief due and so that HMRC realise your gross earnings had now fallen below £100k so reinstate the personal allowance.
I did this last year - paid (via a payroll deduction) as much into my pension as I could to get below £100k. HMRC thought I was earning over £100k so had taxed me accordingly. When I then did my tax return, I got a nice rebate reflecting reinstatement of the personal allowance.
I think you're almost correct, although it looks like you're double counting some basic rate tax relief. If your gross earnings are £120k then you need to reduce these gross earnings to £100k. By paying £20k (gross) into your pension you will save £11,242 (i.e. 60% x £16,210 + 40% x £3,790). So a £20k input into your pension ends up costing you just £8,758.
The actual amount you'd need to pay in depends on how you contribute to your pension - e.g. are you paying gross from company payroll, or are you paying net of basic rate tax into a personal pension?
If you're paying gross into a company pension via a payroll deduction then simply have £20k deducted - even better is if you can "sacrifice" the salary so that you and your employer save NI too.
If you're paying net of basic into a personal pension then the maths is a little more convoluted but it amounts to the same thing. Basically, the insurer claims back basic rate tax of 20% so you would need to send a cheque to them for £16k. The insurer grosses this up to £20k. You would then need to do a tax return to reclaim the remainder of the 40% relief due and so that HMRC realise your gross earnings had now fallen below £100k so reinstate the personal allowance.
I did this last year - paid (via a payroll deduction) as much into my pension as I could to get below £100k. HMRC thought I was earning over £100k so had taxed me accordingly. When I then did my tax return, I got a nice rebate reflecting reinstatement of the personal allowance.
You are close but not exactly correct.
Your calculations re the effect of loosing the PA with a £120k salary are correct - its painful as some of my clients who chose to ignore my advice re mitigtion for 2011/12 are now finding out!
Personal pension and charitable gift aid payments are deductible from your earnings for allowance restriction purposes which is good. Your 20k is actually grossed up by HMRC by 5k so 25k in the pot, and you would effectively obtain a refund of another £5k for the higher rate tax relief. You would also avoid the allowance restriction so when your Tax return is processed, HMRC would also refund the tax withdrawn on the personal allowance equating to 60% x £18210 = £10926.
So your cashflows are £20k into pension, rebated tax of £15926 so fraction over £4k down and in return you get £25k in the pension.
Decision is simple surely??
David
PS I normally charge for that!
Your calculations re the effect of loosing the PA with a £120k salary are correct - its painful as some of my clients who chose to ignore my advice re mitigtion for 2011/12 are now finding out!
Personal pension and charitable gift aid payments are deductible from your earnings for allowance restriction purposes which is good. Your 20k is actually grossed up by HMRC by 5k so 25k in the pot, and you would effectively obtain a refund of another £5k for the higher rate tax relief. You would also avoid the allowance restriction so when your Tax return is processed, HMRC would also refund the tax withdrawn on the personal allowance equating to 60% x £18210 = £10926.
So your cashflows are £20k into pension, rebated tax of £15926 so fraction over £4k down and in return you get £25k in the pension.
Decision is simple surely??
David
PS I normally charge for that!
sumo69 said:
You are close but not exactly correct.
Your calculations re the effect of loosing the PA with a £120k salary are correct - its painful as some of my clients who chose to ignore my advice re mitigtion for 2011/12 are now finding out!
Personal pension and charitable gift aid payments are deductible from your earnings for allowance restriction purposes which is good. Your 20k is actually grossed up by HMRC by 5k so 25k in the pot, and you would effectively obtain a refund of another £5k for the higher rate tax relief. You would also avoid the allowance restriction so when your Tax return is processed, HMRC would also refund the tax withdrawn on the personal allowance equating to 60% x £18210 = £10926.
So your cashflows are £20k into pension, rebated tax of £15926 so fraction over £4k down and in return you get £25k in the pension.
Decision is simple surely??
David
PS I normally charge for that!
Seriously Your calculations re the effect of loosing the PA with a £120k salary are correct - its painful as some of my clients who chose to ignore my advice re mitigtion for 2011/12 are now finding out!
Personal pension and charitable gift aid payments are deductible from your earnings for allowance restriction purposes which is good. Your 20k is actually grossed up by HMRC by 5k so 25k in the pot, and you would effectively obtain a refund of another £5k for the higher rate tax relief. You would also avoid the allowance restriction so when your Tax return is processed, HMRC would also refund the tax withdrawn on the personal allowance equating to 60% x £18210 = £10926.
So your cashflows are £20k into pension, rebated tax of £15926 so fraction over £4k down and in return you get £25k in the pension.
Decision is simple surely??
David
PS I normally charge for that!
Just on the operational way for me to do this - when do I have to make the pension payment by (beginning of April 2013?) and then fill in my tax return with details?
Bandit
Now you want the icing from me as well as the cake!
Pension must be paid by the end of the tax year and shown on your tax return for 2012/13 thats due by 31 January 2014, though the earlier you make it the faster you get the £16k app refunded.
Do you need a (good) accountant??? Your less than an hour from me.
David
Now you want the icing from me as well as the cake!
Pension must be paid by the end of the tax year and shown on your tax return for 2012/13 thats due by 31 January 2014, though the earlier you make it the faster you get the £16k app refunded.
Do you need a (good) accountant??? Your less than an hour from me.
David
sumo69 said:
You are close but not exactly correct.
Your calculations re the effect of loosing the PA with a £120k salary are correct - its painful as some of my clients who chose to ignore my advice re mitigtion for 2011/12 are now finding out!
Personal pension and charitable gift aid payments are deductible from your earnings for allowance restriction purposes which is good. Your 20k is actually grossed up by HMRC by 5k so 25k in the pot, and you would effectively obtain a refund of another £5k for the higher rate tax relief. You would also avoid the allowance restriction so when your Tax return is processed, HMRC would also refund the tax withdrawn on the personal allowance equating to 60% x £18210 = £10926.
So your cashflows are £20k into pension, rebated tax of £15926 so fraction over £4k down and in return you get £25k in the pension.
Decision is simple surely??
David
PS I normally charge for that!
Hmmm. That feels too much to me - I think there is some double counting going on. You're including 60% for the reinstatement of the personal allowance - it should only be 20% as you have already included the higher rate tax relief on the pension contribution.Your calculations re the effect of loosing the PA with a £120k salary are correct - its painful as some of my clients who chose to ignore my advice re mitigtion for 2011/12 are now finding out!
Personal pension and charitable gift aid payments are deductible from your earnings for allowance restriction purposes which is good. Your 20k is actually grossed up by HMRC by 5k so 25k in the pot, and you would effectively obtain a refund of another £5k for the higher rate tax relief. You would also avoid the allowance restriction so when your Tax return is processed, HMRC would also refund the tax withdrawn on the personal allowance equating to 60% x £18210 = £10926.
So your cashflows are £20k into pension, rebated tax of £15926 so fraction over £4k down and in return you get £25k in the pension.
Decision is simple surely??
David
PS I normally charge for that!
You're not going to save more than 60% at the most - you have him saving almost 85% which can't be right.
Plus, he will have paid £25k (gross) into his pension when he only needs to pay £20k (gross).
Zigster said:
Hmmm. That feels too much to me - I think there is some double counting going on. You're including 60% for the reinstatement of the personal allowance - it should only be 20% as you have already included the higher rate tax relief on the pension contribution.
You're not going to save more than 60% at the most - you have him saving almost 85% which can't be right.
Plus, he will have paid £25k (gross) into his pension when he only needs to pay £20k (gross).
ZigsterYou're not going to save more than 60% at the most - you have him saving almost 85% which can't be right.
Plus, he will have paid £25k (gross) into his pension when he only needs to pay £20k (gross).
I think they are right when comparing to the OP's original position with no personal allowance or pension contribution.
If you want to run the figures through your tax software, I am sure you will draw the same conclusion as me.
As regards the pension, OP clearly stated he would pay £20k which automatically gets topped up to £25k by HMRC - it could have been 16k to give 20k gross which would of course reduce the amount refunded by £1k.
So he would have paid £16k out,receive £15k app refund from HMRC so for a net £1k he has £20k in the pension!!
Feel free to PM me if you want further details.
David
Edited by sumo69 on Thursday 15th November 14:33
Zigster said:
- even better is if you can "sacrifice" the salary so that you and your employer save NI too.
I do sacrifice via my employer and they put their NI savings into my pension as well. Allowing for withdrawal of child benefit, I was shocked when I worked out my marginal rate as 63%. (includes income tax, employer NI and employee NI)So for every £37 I give up in net income, I get £100 in pension. But ... it gets better.
I can then take out £25 at age 55 so overall, I give up £12 in net income to get £75 in pension. That pension will then be paid out gradually with no national insurance deductions.
Salary sacrifice with employer contributing the NI savings is so good, I can't believe it will continue. I'm dumping about a third of gross salary into pension this way. (and keeping annual pension costs down to 0.6%)
sumo69 said:
Zigster
I think they are right when comparing to the OP's original position with no personal allowance or pension contribution.
If you want to run the figures through your tax software, I am sure you will draw the same conclusion as me.
As regards the pension, OP clearly stated he would pay £20k which automatically gets topped up to £25k by HMRC - it could have been 16k to give 20k gross which would of course reduce the amount refunded by £1k.
So he would have paid £16k out,receive £15k app refund from HMRC so for a net £1k he has £20k in the pension!!
Feel free to PM me if you want further details.
David
We might be talking at cross purposes here because I don't see how your numbers can be right, either by doing detailed calcs or by stepping back and considering that the tax benefit can't be greater than 60% if the marginal income tax rate doesn't go above 60%.I think they are right when comparing to the OP's original position with no personal allowance or pension contribution.
If you want to run the figures through your tax software, I am sure you will draw the same conclusion as me.
As regards the pension, OP clearly stated he would pay £20k which automatically gets topped up to £25k by HMRC - it could have been 16k to give 20k gross which would of course reduce the amount refunded by £1k.
So he would have paid £16k out,receive £15k app refund from HMRC so for a net £1k he has £20k in the pension!!
Feel free to PM me if you want further details.
David
Edited by sumo69 on Thursday 15th November 14:33
If gross taxable income is £120,000, tax paid is £41,126 for 2012/13 and net income is £78,874. If gross taxable income is £100,000, tax paid is £29,884 for 2012/13 and net income is £70,116. (I did a little spreadsheet but there is a calculator on moneysavingexpert which confirmed I hadn't made a mistake.)
So paying £20k into the pension scheme (i.e. reducing gross income from £120k to £100k) reduces net pay by £8,758. That is, a gross contribution of £20k would cost the OP £8,758 out of net income . (NI savings possibly on top depending on how the OP is paid and how he pays the money into the pension scheme.)
I still think you're double counting the removal of the personal allowance. The removal of the personal allowance is equivalent to a 20% marginal income tax rate in addition to the 40% which also applies. Your figures treated the removal of the personal allowance as equivalent to a 60% marginal income tax rate all by itself.
Fair point that the OP does say he wants to pay £20k into his pension scheme but, given the way he phrased it, I took that as meaning that he wants to get his £120k gross down to £100k gross so that he avoids the 60% tax. And, that he had misunderstood how much he needed to pay into his pension scheme to achieve that. As you say, whether we call it a gross contribution of £20k or £24k doesn't make much difference to the end result. A gross contribution of £24k (i.e. £20k net of basic rate tax) would reduce gross income from £120k to £96k and cost the OP a net £11,158. Still a great deal but quite a lot less than the net £4k you were suggesting.
Zigster
I am a bit tied up in client meetings the rest of this week so over the weekend I will bash the figures out again - one things for sure, there is a piece of the jigsaw missing from one of our analysis!
I took some reassurance that my regular reviewer/commentator has posted above without appearing to want to correct any of my figures and conclusions - that's not to say its his issue or your wrong but just a point of note.
I know the conclusion drawn is agreed that the pension is a bargain when loosing personal allowances is the alternative option, so I will rework this over the weekend and post again.
By the way, are you an accountant?
David
I am a bit tied up in client meetings the rest of this week so over the weekend I will bash the figures out again - one things for sure, there is a piece of the jigsaw missing from one of our analysis!
I took some reassurance that my regular reviewer/commentator has posted above without appearing to want to correct any of my figures and conclusions - that's not to say its his issue or your wrong but just a point of note.
I know the conclusion drawn is agreed that the pension is a bargain when loosing personal allowances is the alternative option, so I will rework this over the weekend and post again.
By the way, are you an accountant?
David
Clearly I'm interested in how this pans out!
Just some points of clarification if it helps.
I already pay into my pension through salary sacrifice. This extra £20k into the pension would be above and beyond this and paid out of savings that have already been taxed, so assume I get a tax rebate. My total pension contribution for the year should still be under £50k.
HMRC have indicated they have updated my tax code as they believe I will not be eligibility to any tax free allowance this year. Thus I expect to be able to recover the 40% tax paid on the £9100 tax free allowance for 2012/13 if I drop my taxable earnings under £100k
Just some points of clarification if it helps.
I already pay into my pension through salary sacrifice. This extra £20k into the pension would be above and beyond this and paid out of savings that have already been taxed, so assume I get a tax rebate. My total pension contribution for the year should still be under £50k.
HMRC have indicated they have updated my tax code as they believe I will not be eligibility to any tax free allowance this year. Thus I expect to be able to recover the 40% tax paid on the £9100 tax free allowance for 2012/13 if I drop my taxable earnings under £100k
sumo69 said:
By the way, are you an accountant?
I'm a pensions actuary, although I generally deal with large corporate schemes rather than individual advice (but I have done exactly what Bandit has been suggesting for the last couple of years which is why I'm reasonably confident I know what I'm doing).@ Bandit
Do think about whether you need to pay £20k or £24k (or whatever the right figure is - see the comments above from sumo69 and me), although there's no harm paying more (as long as it's not more than £50k in total). The way you're thinking about it is right - you get the 40% tax relief you would normally get plus 40% of £8,105 (which is the personal allowance for 2012/13) so a further £3,242.
Ok - my 9am meeting got postponed so I have actually got a bit of time to get the pen, paper and calculator and work this through.
On a gross salary of £120k with no pension contribution to reduce this, the tax liability paid at source via PAYE is £41126 - at this income level you receive no tax-free personal allowance.
If you were to make a 16k personal pension contributution, this is grossed-up to £20k automatically by HMRC and has the effect of extending your income charged at the basic 20% rate by the same amount and reinstates your personal allowance - I make it that your tax liability would amount to £33884 so you would receive a refund from HMRC of £7242.
Using a 20k PPC increases the grossed-up pension contribution to £25k and increases the tax refund to £8242.
So your £20k pension pot would cost you £8758 (being £16k less £7242) or your 25k pension pot would cost you £11758 (being £20k less £8242).
Apologies to Zigster - his Actuarial brain is brighter than mine - that will teach me to post whilst sitting on the London Underground surfing the forums on my I phone!
Bandit - the "price" of your pension pot is higher than I originally quoted, but still a real "steal" if you can afford to pay the contribution without effecting your lifestyle or spending requirements.
Hope we are all happy now!
David
On a gross salary of £120k with no pension contribution to reduce this, the tax liability paid at source via PAYE is £41126 - at this income level you receive no tax-free personal allowance.
If you were to make a 16k personal pension contributution, this is grossed-up to £20k automatically by HMRC and has the effect of extending your income charged at the basic 20% rate by the same amount and reinstates your personal allowance - I make it that your tax liability would amount to £33884 so you would receive a refund from HMRC of £7242.
Using a 20k PPC increases the grossed-up pension contribution to £25k and increases the tax refund to £8242.
So your £20k pension pot would cost you £8758 (being £16k less £7242) or your 25k pension pot would cost you £11758 (being £20k less £8242).
Apologies to Zigster - his Actuarial brain is brighter than mine - that will teach me to post whilst sitting on the London Underground surfing the forums on my I phone!
Bandit - the "price" of your pension pot is higher than I originally quoted, but still a real "steal" if you can afford to pay the contribution without effecting your lifestyle or spending requirements.
Hope we are all happy now!
David
It's the reason why I tend to shy away from detailed computations and calculations when posting on internet forums. It's so easy to be "not quite right" - and such calculations can be time consuming.
If I am going to get involved in such calculations - I would want to be paid for the privilege too.
If I am going to get involved in such calculations - I would want to be paid for the privilege too.
Hats off to the PHers who have given their time to this one.
Question:
I recently asked my acountant, who I pay a few hundred a year, if there was any way I could reduce my tax liability as am basically in the situation used on your example. He drew a blank and basically said as I was PAYE id have to suck it up...
Is the advice above common knowledge amongst tax folk or a specialist area that I might be unreasonable in expecting him to know? To me it seems that this is pretty obvious advice to give to someone in mine and the OPs position, relatively speaking.
Question:
I recently asked my acountant, who I pay a few hundred a year, if there was any way I could reduce my tax liability as am basically in the situation used on your example. He drew a blank and basically said as I was PAYE id have to suck it up...
Is the advice above common knowledge amongst tax folk or a specialist area that I might be unreasonable in expecting him to know? To me it seems that this is pretty obvious advice to give to someone in mine and the OPs position, relatively speaking.
Hmmmm me to... Especially when one is falling into the 60% tax trap. This is one of the big national firms (three letters beginning with P), and I'm dealing with a 'senior' tax advisor apparently.
Forgive me, but how does it effect those with wide fluctuations in earnings, should one be adjusting contributions to suit that years given earnings?
Forgive me, but how does it effect those with wide fluctuations in earnings, should one be adjusting contributions to suit that years given earnings?
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