Pension question

[Crumpet]

Over the years I've neglected my pension and paid very little into it, so I have what I hope isn't an unbelievably stupid question.

For instance (hypothetically): I have savings and assets (that will be sold and currently earn very little interest) that provide a sum large enough to effectively pay myself a salary from the proceeds for 24 months. Eg. Savings and assets equal £48,000, split over 24 months would give me £2000 a month.

Can I then put my entire salary from employment over and above the basic allowance but below the £40,000 annual cap into my pension? Such that I'd pay no income tax and effectively earn 20% to 40% more, albeit with the money being inaccessible and stuck in a pension.

The earnings on the £10,800 basic allowance would then be added to the £2000 a month from savings to give a total monthly 'salary'.

Am I being completely stupid here and missing something, or would this actually work and be benficial? (And also give my pension fund a significant kick up the arse.)

[PurpleMoonlight]

No not stupid (in terms of what you can do).

The personal allowance for income tax is £11,000 for 2016-17 though.

If your 'adjusted income' is over £150,000 HMRC operate a reducing pension contribution annual allowance though, but as you don't mention 45% tax I guess you don't have that.

[Crumpet]

No, nowhere near the £150k mark! Just into the 40% bracket at the moment.

So in theory this approach would work and see me get paid effectively 20% extra between the £11,000 basic allowance and the start of the 40% bracket and effectively a 40% increase in anything over that amount?

[PurpleMoonlight]

Yes, but whether or not it is advisable to do it is a different matter.

How old are you?

[Crumpet]

Age 33, was looking at it as an option for 12-24 months to get my pension up to an acceptable level. Got my wife's salary as backup over that period as well as the saleable assets so I don't think we'd starve. No expensive purchases or holidays planned.

I'd be keen to hear any of the drawbacks and downsides though as I know very little about pensions.

[PurpleMoonlight]

I'm not an IFA but do work in the industry.

I think you should be looking at establishing a proper long term pension provision strategy rather than a short term panic fix, that probably isn't.

[supersport]

Why not just put the £48K in your pension over 2 years, get the same relief without mucking about. Assuming that, that is a prudent thing to do.

You still need to think about a longer term approach to pensions though. Such as just upping your monthly contributions?

If your employer matches your contributions, then you want to at least match these as a minimum as it's free money. Given that you get 40% relief on your contributions, and if you are paying by salary sacrifice, then it won't cost you as much as you think, at least in your monthly pocket. In this case though, I am not sure if it makes sense to keep your contributions at a level that just keeps you int he 40% bracket or not. Off of the top of my head this seems sensible. Dependant on the amount of interest you are earning elsewhere.

[TwigtheWonderkid]

supersport said:

Why not just put the £48K in your pension over 2 years, get the same relief without mucking about.

This was my first thought. Ignoring the issue of how good an idea it is, it seems an easier way of achieving the same thing.

[walm]

TwigtheWonderkid said:

supersport said:

Why not just put the £48K in your pension over 2 years, get the same relief without mucking about.

This was my first thought. Ignoring the issue of how good an idea it is, it seems an easier way of achieving the same thing.

Can't you do £48k using carry forwards?

[Crumpet]

TwigtheWonderkid said:

supersport said:

Why not just put the £48K in your pension over 2 years, get the same relief without mucking about.

This was my first thought. Ignoring the issue of how good an idea it is, it seems an easier way of achieving the same thing.

Does it achieve the same thing? I'd then be back to paying tax on my employment income and therefore lose out on 20% to 40% tax relief on what I put in the pension. If I lived off my lump sum and savings I wouldn't pay income tax on it? Right?

I do agree that I need a long term strategy though. This was sort of my way of making up for being slack over the past 10 years!

[oyster]

I've done just this.

I had some spare allowance from previous years' allowances and so opted to go for a 90% salary sacrifice. It's taken my taxable income down to near minimum wage levels.

It's not just the saved income tax and NICs from the pension contributions.

It means I get to keep my child benefit (£1,700).
I get to buy twice as many childcare vouchers (£2,916 instead of £1,488)
I get to claim tax credits (possibly some £5,000)
I get to claim the married tax allowance (another £212)
I don't have to pay any extra tax on share dividends or bank savings.
I get 41% relief on gift aid instead of 20%.
Tax relief on work expense claims is now 61% instead of 40%.

If I instead opted to contribute a lower but consistent percentage to pensions then I'd receive none of the above benefits.

[PurpleMoonlight]

Crumpet said:

Does it achieve the same thing? I'd then be back to paying tax on my employment income and therefore lose out on 20% to 40% tax relief on what I put in the pension. If I lived off my lump sum and savings I wouldn't pay income tax on it? Right?

I do agree that I need a long term strategy though. This was sort of my way of making up for being slack over the past 10 years!

HMRC don't specify that the money has to physically come from the net PAYE income. Providing you have sufficient taxable PAYE income you can use cash savings to make the physical contribution.

You pay net of basic rate tax, so a say £800, and the pension provider will claim the £200 tax you have paid to HMRC and add to your pension arrangement. If the contribution is subject to higher rate tax then you get that back (another £200) from HMRC in cash via your annual tax return.

If it were me I would keep the savings and establish a 10% of salary pension contribution going forward (or whatever salary is subject to 40% tax if higher). You can then dip into your savings should you need any additional cash at some point.

Edited by PurpleMoonlight on Tuesday 5th April 13:13

[Crumpet]

PurpleMoonlight said:

If it were me I would keep the savings and establish a 10% of salary pension contribution going forward (or whatever salary is subject to 40% tax if higher). You can then dip into your savings should you need any additional cash at some point.

Edited by PurpleMoonlight on Tuesday 5th April 13:13

I think that's my most likely route. I've had a play around with a few calculators and assuming 10% of salary it works out to an acceptable amount in the future. Especially coupled with my wife's public sector pension and a couple of rental properties. I suppose there's only so much planning you can do without compromising your lifestyle today!

Oyster: I don't fully understand what you mean, but are you saying that by putting all your salary into a pension and effectively taking home minimum wage it has basically allowed you to go 'on benefits'?

[oyster]

Crumpet said:

Oyster: I don't fully understand what you mean, but are you saying that by putting all your salary into a pension and effectively taking home minimum wage it has basically allowed you to go 'on benefits'?

It allows me (for 1 year at least) to get all the 'perks' associated with being a basic rate taxpayer. And my wife is a stay at home mum.

It's ironic that large amounts of these perks available only to basic rate taxpayers have been introduced by a 'Tory' chancellor.

It also shows the horrendous 'benefits trap' we've created in this country. For every pound I have sacrificed to pension at around the £15k level, it has only 'cost' me about 27p (an effective tax rate of 73%). How do we encourage people to work harder when they will be taxed at 73%?

[Ozzie Osmond]

oyster said:

How do we encourage people to work harder when they will be taxed at 73%?

I'm not convinced that's a realistic thing to say. There are various thresholds in the tax system where curious effects are found and you have simply chosen to exploit one of them.

For instance, between about £100k and £120k there's an effective income tax rate of 60% as the personal allowance is withdrawn from 40% taxpayers.

[PurpleMoonlight]

Ozzie Osmond said:

oyster said:

How do we encourage people to work harder when they will be taxed at 73%?

I'm not convinced that's a realistic thing to say. There are various thresholds in the tax system where curious effects are found and you have simply chosen to exploit one of them.

For instance, between about £100k and £120k there's an effective income tax rate of 60% as the personal allowance is withdrawn from 40% taxpayers.

I think Oyster is including the reduction in tax credits as income increases.

[oyster]

Ozzie Osmond said:

oyster said:

How do we encourage people to work harder when they will be taxed at 73%?

I'm not convinced that's a realistic thing to say. There are various thresholds in the tax system where curious effects are found and you have simply chosen to exploit one of them.

For instance, between about £100k and £120k there's an effective income tax rate of 60% as the personal allowance is withdrawn from 40% taxpayers.

It's 62% at that point. But yes it is another anomaly which acts as a disincentive to work harder.


So first there's the tax credit anomaly.
Then there's the child benefit one.
And the personal allowance withdrawal one.

Very messy.

[walm]

oyster said:

It's 62% at that point. But yes it is another anomaly which acts as a disincentive to work harder.

It's not a disincentive to work harder.
That's the whole point of progressive tax rates.

You don't hit the 40% rate say and then decide to stop working or refuse a raise because the tax rate is higher on the extra money.

It is STILL EXTRA MONEY!!!

Sure, diminishing returns and there is a CHANCE that you hit a point where you would rather not work and have more free time but usually more money is still more money, isn't it?

[theboss]

walm said:

It's not a disincentive to work harder.
That's the whole point of progressive tax rates.

You don't hit the 40% rate say and then decide to stop working or refuse a raise because the tax rate is higher on the extra money.

It is STILL EXTRA MONEY!!!

Sure, diminishing returns and there is a CHANCE that you hit a point where you would rather not work and have more free time but usually more money is still more money, isn't it?

You're correct at 40% - but there comes a tax rate at which most people simply won't work because the small percentage of income retained isn't worth the extra effort to earn it.

From this year if my wife or I exceed £50k we are taxed at a marginal rate of 71% thanks to the child benefit removal and dividend tax. I won't ever allow our taxable incomes to go there - I'll just pay an extra earnings into our SIPPs and when the SIPP contribution reaches a limit we won't earn any more.

I get it, that if our incomes were £500k we might not care so much about it, but if you're only likely to exceed the extortionate marginal tax bracket by a small margin then it's simply not worth breaching it in the first place.

Can completely relate to what oyster is saying above.

[LeoSayer]

oyster said:

I've done just this.

I had some spare allowance from previous years' allowances and so opted to go for a 90% salary sacrifice. It's taken my taxable income down to near minimum wage levels.

It's not just the saved income tax and NICs from the pension contributions.

It means I get to keep my child benefit (£1,700).
I get to buy twice as many childcare vouchers (£2,916 instead of £1,488)
I get to claim tax credits (possibly some £5,000)
I get to claim the married tax allowance (another £212)
I don't have to pay any extra tax on share dividends or bank savings.
I get 41% relief on gift aid instead of 20%.
Tax relief on work expense claims is now 61% instead of 40%.

If I instead opted to contribute a lower but consistent percentage to pensions then I'd receive none of the above benefits.

Me too, although at 100% for 6 months via salary sacrifice.

There no NI to pay at all for those months but the really shocking thing is the tax rebate in my monthly pay packet.