Article published on The Barrister Lifestyle Blog March 2015
Many people are wary of pensions, believing they are poor value and also not wanting their money to be “locked away” rather than free for them to access whenever they want it. When you want to get it out you either have to buy an annuity, which means you lose all the capital and just have an income, or you have to follow some very strict rules on how much you can take out.
But these suspicions mean many people are missing out on some very generous tax benefits. A good tax adviser will be able to show you exactly how you personally can benefit, but here is a reminder of what you may be missing if you do not take full advantage of a pension scheme.
*Paying money into a pension is one way you can reduce your tax bill tax in a perfectly legal and ethical way.
*You will get tax relief at your highest marginal rate on payments you make into your pension, provided you do not break any of the rules on pension investments. Your tax adviser will help you avoid breaking those rules.
*Most people probably think that the highest marginal rate of income tax is 45%. It can be higher though. If you earn over £100,000 you will start to lose your tax free personal allowance. This means your effective tax rate could be 60% rather than 40% or 45%.
Imagine you have £8,000 you want to invest. Also imagine your income for the year is £110,000. Invest £8,000 into a personal pension. The pension provider will claim an additional £2,000 from HM Revenue & Customs, so your £8,000 investment will immediately have jumped by 25% to £10,000. For tax purposes you will be treated as having made a £10,000 pension investment. This will bring your taxable income down from £110,000 to £100,000. Now you only have £100,000 taxable income you will not lose any of your personal allowance. You will therefore get a reduction of £4,000 in your tax bill (£6,000, less the £2,000 you have already received from HM Revenue & Customs into your pension). This means for an effective investment of £4,000 you have £10,000 in your pension. How many investments could give you this kind of initial return?
And the investment of the £10,000 continues in the relatively benign tax environment, where qualifying pensions are not subject to tax on income and gains building up in the pension fund.
Should you want to take the money out, the first 25% is tax free. In our example this means you could take out £2,500. Under new “pension freedom” regulations due to be introduced this April you will be able to take out as much as you like, but if you take out any more than 25% you will pay tax at your highest marginal rate. If you decide to take everything out, that will be another £7,500 after your tax free £2,500. If you are still effectively a 60% taxpayer that means you will pay £4,500 income tax, leaving you £3,000 net.
There are limits just as you would expect. There is a limit on how much you can have in total in your pension and on how much you can invest each year. The limit on how much you can invest will also be greatly reduced if you take advantage of “pension freedom” and start drawing extra money out of your pension. There are ways you can get around this reduction if you take action before this April.
For more information about how we can help you and your business, and to find out how you can use your pension to reduce your tax bill, please contact your usual Beavis Morgan partner.