Autumn Statement: Don't raid pensions, George

Ed Bowsher
by Lovemoney Staff Ed Bowsher on 04 December 2012  |  Comments 35 comments

There's been a lot of speculation that the Chancellor George Osborne will cut tax relief on pensions in tomorrow's Autumn Statement. That would be a mistake.

Autumn Statement: Don't raid pensions, George

Read what was announced in Autumn Statement 2012: what it means for you

We’ve been down this road before. Back in February I feared that the Chancellor would cut pension tax relief in March’s budget, following frenzied speculation that he'd set his sights on our retirement cash. Thankfully in the end nothing happened.

In the last few weeks, we’ve once again seen lots of speculation that a cut in relief will be announced tomorrow. The speculation is so widespread, I fear it’s true. However, I very much hope that I’m wrong.

Higher rate relief

The Chancellor could cut tax relief in two ways. Firstly, he could abolish higher rate tax relief on pension contributions.

Let’s say you’re a higher rate taxpayer earning £50,000 a year. You save £4,000 from your post-tax salary into a pension pot, and you then use that pot to give you an income when you retire.

As things stand, the Government gives you full tax relief on that £4,000 contribution, and so pays an extra £2,666 into your pension pot. In other words, for every 60p saved into a pension by a higher-rate taxpayer, the Government contributes 40p in tax relief to make it up to £1.

If you’re a basic rate taxpayer, the Government only contributes 20p in tax relief to your pension pot. So if you contributed £4,000, the Government would only add £1,000 to your contribution.

Osborne may change the rules so that all pension savers receive tax relief at 20% on pension contributions. Abolishing higher rate relief could raise around £7 billion a year for the Government.

Tax-free allowance

Osborne’s second possible cut would be to reduce the tax-free allowance for pension contributions.

As things stand, any worker can save his whole year’s earnings into a pension tax-free, up to a maximum of £50,000. If an employer contributes to a worker’s pension pot, the total contributions from both the employer and employee can’t exceed the annual allowance.

However, there’s speculation that Osborne may cut the annual pension allowance to £40,000 or even £30,000. Cutting the allowance to £30,000 could raise around £1.8 billion a year for the Government.

What’s wrong with these cuts?

Now you might think that these cuts seem reasonable. After all, they’re only likely to affect higher rate taxpayers earning a lot more than the average UK wage.

But I disagree.

My main beef is that the annual allowance has already been cut in this Parliament and I think any further cuts would only create an impression that the rules on pension saving change every couple of years.

If you want to get as many people as possible to save for their retirement, you need to have stable, trusted regulation. If you’re worrying every year that the tax rules on pensions will change, you may decide that saving into a pension just isn’t worth the worry and the hassle.

And that would be a great shame. We need everyone to contribute significant amounts of money into their pensions and that applies to people on higher incomes as well as poorer folk.

It’s also worth noting that a cut in the annual allowance could affect some public sector employees who don’t consider themselves rich – such as head teachers and senior doctors.

Most public sector workers are in defined benefit or final salary schemes where they’ll get a pension based on the size of their salary when they worked.

Now if you’re in a defined benefit scheme and you get a promotion, the value of your pension may rise dramatically in that year. That one-off rise in value could easily be larger than £30,000 and trigger a one-off tax bill if the annual allowance was £30,000. This change could potentially affect anyone in a defined benefit scheme who gets a promotion and currently earns more than £40,000 a year.

What would I do instead?

Don’t get me wrong. I think it’s important that richer people pay more tax. I just don’t think that cutting pension relief is the best way to do it. My preference would be for a mansion tax. It’s a difficult tax to avoid and it may also help to reduce property prices.

I realise that Osborne has already ruled out a mansion tax this week, but he hasn’t ruled out anything when it comes to pensions.

However, cutting pension relief would be short-sighted. If people don’t save for their retirement, future governments will have to support more elderly people who have no other source of income. But if a government encourages people to save, more retirees will be able to look after themselves. Isn’t that a traditional Conservative principle?

More on pensions and tax:
New pensions code to boost your retirement pot

Workplace pensions: what it means for you
How to copy Starbucks and pay no tax

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Comments (35)

  • pc2574
    Love rating 13
    pc2574 said

    A mansion tax seems like a terrible idea for the same reason that you say further interference with pensions is a bad idea - that such interference will alter a fairly stable market. By artificially introducing a new factor to the housing market, it could create chaos where we desperately need stability. Furthermore, it is likely to have a disproportionate affect on those who have put their faith in bricks and mortar over the years and would be extremely hard to calculate/police without creating an enormous public sector force of valuers.

    In my opinion, the fairest way of taxing anything is applying taxes to the flow of assets (e.g. VAT, Stamp Duty, Income Tax above the personal allowance). If these are all increased, the rich who spend their money are hit the hardest and the poor, who spend most of their money on essentials like food, rent and power, will pay the least.

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  • Ed Bowsher
    Love rating 80
    Ed Bowsher said

    Hi pc2574,

    But there's a big difference. Interfering in the stable pensions market may discourage people from saving into pensions, and that's a bad thing. We need people to save into their pensions.

    Interfering in the property market may discourage from over-investing in property, and that can only be a good thing. I would welcome falling house prices. Our over-valued property market is a problem. And anyway, taxing property is a better way to hit the vast majoriry of wealthy people. Income tax is easy to avoid.

    Ed

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  • nikwilson
    Love rating 0
    nikwilson said

    Can you go over that pension calculation again - £70k earnings and yet I can get in £83,333.00 into a pension based on mine and my employers payment of £50k - 40% gross tax relief on the whole contribution????? Can you show how you got to this figure in calculation format as I am very excited by such an ability to get £33,333.00 from HMRC into my pension for a payment of £50k. I take it that there is no use of any carry forward or manipulation of the pension input periods as well.

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  • Basia02a
    Love rating 49
    Basia02a said

    Removing higher rate relief on pensions would make the higher bands more effective, as at the moment they can just save it into a pension and not pay higher rate tax unless they hit the 50k(?) limit. The majority dont even earn this never mind put it in a pension. Also this group are the only people geting a tax cut this year! If you are defending this limit and cannot afford to pay 50K a year into a pension, you must be crazy.

    Instead of a mansion tax why don't they just indeed a new higher rate of Council tax. this would be less onerous, and still largely effect those who are bettter placed to afford it. Admittedly it would not bring in as much money. These Bands were set 20 years ago, and the prices of houses at the top have risen a lot.

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  • tindeanboy1
    Love rating 15
    tindeanboy1 said

    Your preferred option is a mansion tax!

    I'm unfortunate to have spent all my life in a small village in Cornwall that all the "Right on yah" yuppie types from (mostly the South East) have bought up as second and retirement homes.

    They've pushed the house prices around here into the stratosphere!

    Your clever idea (probably because you're in the 40% bracket) would mean that I'd have to sell up because any mansion tax.

    There's only three local families in this village now, it's about time some of the overpaid, self-serving middle class from the South East felt the cold wind of recession like the rest of us.

    No, let the people paying 40% pay their share.

    There are people in this country (paying barely only 20%) that can't even afford a pension.

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  • nikwilson
    Love rating 0
    nikwilson said

    Of course, if you hit the additional income tax rate band at £150k, you get 50% relief tax relief on pension contributions that fall over that band start point. So let's say you earn £250k PAYE and pay in £50k to a pension during the input period of the pension plan you pay into, you pay £40k (net of 20% which is given upfront) and reduce your income tax bill by a further £15k (another 30% of the £50k) by use of self assesment, effectively £25k in the pension funded by HMRC. Now £50k in a pension for a net cost to you of £25k is a good return by any standards.

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  • jedi44
    Love rating 43
    jedi44 said

    As a follow on from what tindeanboy1 said, rather than have an all-out mansion tax which would badly affect people like him who have lived for years in a house that has increased in value due to "yuppies" taking over the neighbourhood, couldn't all second homes be taxed to the hilt. They are a luxury, not a necessity.

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  • IFA
    Love rating 9
    IFA said

    @nikwilson

    £83,333.33 gross contribution = £50,000 net of higher rate tax relief

    20% taken at source (£16,666.66) plus further 20% recovered via self-assessment (£16,666.66)

    £33,333.33 total tax relief

    And people complain that pensions are rubbish!!

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  • tindeanboy1
    Love rating 15
    tindeanboy1 said

    jedi44 has a good idea, if you can afford a second home you're obviously not being taxed enough.

    One of the few good ideas the Lib Dems have is that second homes would need planning consent for change of use, because of the change from residential use.

    Better still take away all the second homes and give them to local young families and let the second home owners stay in council estates when come for their odd visits.

    Why not abolish pension plans altogether, they're certainly not a level playing field.

    If you want to save for retirement do it using existing savings/tax rules that everyone else has to use.

    Public Sector workers on gold plated pensions, executives using pension tax loopholes to avoid paying income tax and the government topping up 20 and 40% pension savers is certainly not fair for people in low paid regions that can't afford to get a look in at all, IT IS NOT A FAIR SYSTEM.

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  • mknee
    Love rating 6
    mknee said

    Unfortunately the 2nd home tax would never happen since just about every MP has a 2nd home - way too many vested interests there.....

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  • oldhenry
    Love rating 343
    oldhenry said

    Where does it say that the planet earth is to be a fair earth? You need to get real. The wealthy will always be so , and the poor will always be with us - see the Bible for that.

    Osborne will take cash wherever he thinks he can without losing too many votes, that is what being in governmnet is about you know.

    I suspect he will leave fuel alone , due to the thrashing in the bye elections, and target what appears to be the 'weathly'. This is for the electorate - not neccessarily common sense.

    By the time many younger people retire the UK will have disintegrated , financially, anyway so who really cares? The population growth is far too high for the number of jobs available meaning that vast numbers be be on benefits , paid for by fewer and fewer people. That does not add up in my simple economic brain.

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  • misswolves
    Love rating 3
    misswolves said

    I think it is too simplistic to simply add extra tax to those people who have two homes- of whom I am one.

    I am a reluctant landlord, with the local council having erected a monstrosity at the front of my house( the size of a portaloo.)they installed it without planning position, but got it retrospectively.

    This monstrosity wiped approximately £20k of the value of my house. I had decided to move to another area 100 mikes away,but couldn't sell it.

    My husband and I then bought a house together and I rented the house out. The rental barely covered the mortgage and letting fees. The tenant drilled through my old doors, smoked, had a pet and moved his mother in there all against the terms of the lease.

    It cost me about £1k to redecorate and repair the damage.

    I was only a nurse when I bought the house in 1999. Since then, i have retrained, done my law degree and Legal Practice Course and I earn less now than I did then.

    Don't make the assumption that all if us second home owners are property magnates. To some of us they are millstones around our necks.

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  • IFA
    Love rating 9
    IFA said

    @tindeanboy1

    I've never understood why people don't think pensions are fair for the lower paid - if you earn under the personal allowance you don't pay any tax, yet you receive basic rate tax relief on any contributions - and in retirement, chances are the pension your pot will provide is also under the then personal allowance (given affordability) you still won't pay any tax. The government is giving it away to the lower paid.

    It's more likely the middle earners that do worse, they pay 20% tax (although not on all of their earnings) receive 20% tax relief on any contributions and will quite probably pay 20% tax in retirement - although then the personal allowance will most probably be higher, so they benefit that way.

    Those earning just over the higher rate tax threshold do well as they most probably will drop into basic rate in retirement, so get 40% tax relief on contributions, but only pay 20% in retirement.

    Or you could save it in an ISA and get no tax relief on contributions at all!!

    As for what will happen tomorrow, I think lowering the Annual Allowance to £40k is most likely and possibly removal of the carry-forward rules.

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  • tindeanboy1
    Love rating 15
    tindeanboy1 said

    misswolves, your argument doesn't command a great deal of sympathy when you complain of tenants and the council daring to build near you (nimby-ism) which lowered the value of your second home.

    Then you compound that failure by saying that you were "only a nurse" but now you're in the legal profession, as though that somehow made you a better human being.

    I'm afraid that Bankers, Tabloid Journalists and the Legal Profession would be lucky to get a place on a lifeboat if the Titanic were to go down in this day and age.

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  • nikwilson
    Love rating 0
    nikwilson said

    Message for IFA, as an IFA and I guess a regulated advisor, are you saying that if I earn £70k pa as stated in the article, that I get totally 40% higher rate relief on a gross contribution of £83.33k? Is not relief given across the bands - in this case on a £70k salary, some tax relief will be at 20% and some at 40%.

    What about the annual allowance charge as well as I have paid in over £50k without the use of carry forward or use of two pension input periods in one tax year.

    I would like Ed to give us his calculation that made him come up with the advice he gave in his article. Is Ed regulated by the FSA?

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  • pc2574
    Love rating 13
    pc2574 said

    Ed,

    How many people realistically can exceed the existing £50kpa tax free limit? It seems to me that people currently in that position are likely to own expensive homes.

    Pc

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  • yocoxy
    Love rating 152
    yocoxy said

    @nikwilson.

    I think you're correct on the first point. 40% relief is only available on the income on which 40% tax is paid.

    On the second point, the £50k limit is £50k of contributions and is not exceeded by the £83k value after tax relief.

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  • nikwilson
    Love rating 0
    nikwilson said

    Hi yocoxy,

    Thank you for the reply. I hate to challenge anyone on what is posted, but the HMRC web site states that the annual allowance is £50k and this is gross, not net after any form of tax relief. Therefore, there would be an annual allowance charge on the pension member if the overall value of the pension contribution for the pension input period exceeds £50k (assuming no carry forward and not using 2 pensions with different input period dates). If you earn £70k pa, the maximum payment that can be made to a pension and gain tax relief at your marginal rates is £70k gross and as this is over £50k, there needs to be some carry forward if unused relief is available OR use of a second pension with a different input period by at least one day (i.e. £50k to one and £20k gross to another). This is a bit more complex but is achievable by clever use of dates.

    The reality is that if you earn say £70k pa, you CAN make a pension contribution of anything you want if you have the cash (with 20% upfront relief) but if this is over the annual allowance then there will be a large tax charge penalty (usually payable by self assessment) which makes making such a large pension contribution redundant in overall benefit.

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  • alexms
    Love rating 8
    alexms said

    The thing about a Mansion Tax is that many (not all) mansions are also historic monuments and one could reasonably argue that occupants of all listed buildings, from mansion to cottage, are spending their taxed income to maintain our heritage for the nation. to charge them extra, in what could also be termed Bitterness Tax, for the privilege, seems both political and destructive unless it is offset by measures to reward the owners for maintaining our heritage - assuming we care about our heritage.

    Without 'doing the maths', I suspect that making maintenance of listed buildings offset-able against tax would end up costing far more than expected. Of course, we don't know how much the mansion tax would be, so it could still break even - financially.

    What would be a good idea and would in effect come to a more efficient version of the same thing would be a property tax that linked floor space to occupancy rates; there are countless houses throughout the UK that are practically empty, usually where older people 'empty-nest' in the family home, often while it falls down around them. This should be taxed into oblivion.

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  • Supercal
    Love rating 3
    Supercal said

    Hopefully for the last time let's kill this canard about 'tax relief'. It is tax deferment. Pensions are not 'tax free' either. They have no more priviliged tax status than ISA's which for the vast majority of 20% taxpayers are a better bet.

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  • nikwilson
    Love rating 0
    nikwilson said

    Come on Ed, show us all how on a salary of £70k you can get £33.33k of tax relief into a pension as you state in your artical by paying in £83.33k gross. A bit of a challenge, but I am sure you must have your research to hand that made you make such a claim.

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  • heigham
    Love rating 0
    heigham said

    My view is that the limit of annual contributions should be set at a level that would cover person to attain a pension of the average wage at retirment date by making regular contributions throughout their working life. I have not yet done any proper calculations, but it would mean a reduction of the limit to less than £30,000 pa, probably less than half.

    The target should be to encourage everybody to start and continue pension contributions throughout their working lives. The current limits in place mean that only the wealthy can make use of the Tax planning elements, while the ordinary person looks at the unimaginable contributions and thinks it is not even worth starting. That has ot change.

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  • nosbort
    Love rating 160
    nosbort said

    It is almost inevitable that various pension tax relief changes will be introduced to 'save the government money' but don't forget that the entire justification for taxing pensions when paid is that the money is saved without tax in the first place. Any increase in the taxation on pension savings will destroy this tenuous logic and we should all do 2 things. 1) stop putting money into the government's piggy bank known as 'pension Savings' 2) start lobbying our MPs and others to point out that if they tax it on the way in then it must not be taxed on the way out.

    All in all, yet another perfect demonstration of why pensions are not a good place to save.

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  • misswolves
    Love rating 3
    misswolves said

    @tindeanboy.

    Boy do you have a chip on your shoulder!

    I made the point about the monstrosity the council installed not because of NIMBY- ism, but because the council broke the law. the point about ' only a nurse' because I was clearly not earning much. I have a great relationship with my current tenant who has been there for over 7 years. The professional who rented it off me before her caused damage as previously illustrated. Surely, you accept that there are good and bad tenants as there are good and bad landlords?

    If I had sold at the price that the estate agents said I would get with the monstrosity being present ( £20k less than I paid for it, it would have pushed me into negative equity.)

    I retrained as a solicitor because I was exposed to a chemical by the health authority that gave me severe asthma. I have the lungs of a 77 year old at 40. I cannot afford to return to my birthplace in Cornwall, which would assist my asthma, as the prices exclude me.

    I still work for the NHS at low pay supporting staff who have been the victims of violence and aggression at work and assisting the prosecution of the perpetrators.

    Sorry there is no room for me on your titanic, but quite frankly if you are on there, whinging with your left wing indoctrination, it is not a place i would want to be. You haven't said what you do to earn your seat, but I am sure that someone else would view you as unnecessary and pointless as you have indicated mine is.

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  • tindeanboy1
    Love rating 15
    tindeanboy1 said

    @misswolves

    The reason I've got annoyed is because people earning enough to get into the 40% tax bracket are plainly earning enough to "share the pain" with the rest of us. Nobody would be taking anything away from them, more like the Government would just be giving them less!

    People on benefits will be getting less - so should the 40%-ers!

    If the Government can afford to top up the pensions of the 40% taxpayers, they should do it for everyone.

    That way everyone could have a better chance of a decent pension.

    I run a minibus carrying special needs children around, my son also drives a special needs minibus and my daughter works in a special needs school for children.

    My wife is a retired care worker - all basic but fairly essential jobs, certainly to the children we deal with.

    We couldn't, in our wildest dreams, earn enough to pay 40% income tax - or afford to buy second homes.

    Why should people who already have reasonably higher wages think that they are entitled to a better pension contribution from the Government as well?

    misswolves, in you first email you stated how bad your tenants were, holes in the doors etc, generally how hard it is to own a second home and what a martyr you are.

    However in your last posting you're glowing about the good relationship you've had with your tenants of seven years. Your words, not mine.

    Your tenants have just paid seven years off your mortgage, which makes for a cheap second home. When you come to sell, I for one won't be especially upset that the Council have built a "Monstrosity" and deprived you of £20,00 more profit.

    The Council probably did it for the sake of the local community.

    Anyway, the second homes I'm talking about are the homes that have been bought up in choice villages that South East types keep empty all year, apart from the few weeks a year when the deign to come down.

    They've killed communities all over the South West and I'd like to see these people hit a lot harder in their wallets.

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  • IFA
    Love rating 9
    IFA said

    @nikwilson

    Sorry, my first post was incorrect; well technically correct as you would get the tax relief on a £50k net contribution, so it would be grossed up to the £83k, but there would then be the annual allowance tax charge which I forgot about - which would wipe out the tax relief in this example.

    You are therefore correct that the £50k annual allowance is gross and it is also inclusive of both employee and employer contributions.

    However, to answer your question regarding tax relief; if you are a higher rate taxpayer, you would receive higher rate tax relief on any contributions. So even if you earn £43k and therefore only pay 40% tax on a very small portion of your salary, you would still be entitled to higher rate tax relief on all of your pension contributions - assuming those contributions don't drop your income below the threshold. There is no some tax relief at one rate and some at another etc...

    Hope that helps.

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  • nikwilson
    Love rating 0
    nikwilson said

    Hi IFA

    Thank you again for your post on this, but it would seem that you are wrong on the 2nd point as well. If what you say is right then if you hit the higher rate tax band and crossi it by say £1.00, you are saying that any contribution you pay to a pension will get 40% relief accross the board. In this scenario, only £1.00 of the pension payment would get 40% relief and the balance would get only 20%. I have checked this and re-checked this over and over again.

    Higher rate relief is reclaimed via self assement and so you will get relief at different rates if the payment to the pension crosses the 20/40 band.

    Please chack again if you wish - I just did with HMRC and it to 2 mins to find out as I really want to get to the bottom of this prior to this afternoons statement.

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  • IFA
    Love rating 9
    IFA said

    Hi nikwilson,

    Definitely not; if you pay higher rate tax of any amount you will get higher rate tax relief on the whole personal pension contribution. It is possible, as mentioned before, that the pension contribution will reduce your relevant earnings to below the higher rate threshold, meaning you would only be entitled to the basic rate tax relief, but assuming this isn't the case, you would get full 40% tax relief.

    Basic rate tax relief will be added straight away and claimed by the provider, higher or additional rate tax relief must be claimed via a self-assessment form or by phoning/writing to HMRC

    So let's say you earn £50k and what to contribute £100 gross per month into a personal pension. Basic rate tax will be claimed at source, meaning that the amount leaving your bank account would be £80 per month. As you are a higher rate taxpayer, the further 20% can be reclaimed via self-assessment or by speaking to HMRC who can adjust your tax code.

    Please let me know where on the HMRC website it suggests anything different?

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  • IFA
    Love rating 9
    IFA said

    George Osbourne has reduced the annual allowance to £40k and the lifetime allowance to £1.25million from the 2014/15 tax year

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  • nikwilson
    Love rating 0
    nikwilson said

    Thank you IFA for that, I understand that if the pension contribution is fully in the higher rate band then you get 20% upfront and 20% via self assesment.

    Lets say the 20/40 band is £48k and I earn £50k, this is only £2k of my earnings in the 40% band. If I pay a singe payment of £5k gross to a personal pension, then I get 20% upfront = £1k, so I write out a cheque for £4k. Surely I only get the additional 20% on that which is in the 40% band = £2k gross, of which I have already had £400.00 upfront and so I can claim a further £400.00 only?

    Is this what you are saying as well????

    Or are you saying that as I earn £50k in this example and I pay in £4k net of 20% = £5k gross, that I can claim another £1k as I am a higher rate payer.

    Please let me know if it is £400.00 I can reclaim or £1k I can reclaim for the higher rate relief as I think this will answer my question.

    Thank you for your help.

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  • misswolves
    Love rating 3
    misswolves said

    @ tindeanboy1.

    You clearly are a martyr, as are your wife and all your family. In your blinkered and hate filled interpretation of my posting you have failed to read my posting correctly ( regarding the first and second tenant) and vilify me for having a second home I do not want.

    I wanted to sell my home to be able to buy a home with my husband. I could not do that as that would leave me oweing £20k I did not own.

    Enjoy your seat on the titanic as I will not make £20k profit, I will just recoup what i put in. The monstrosity should have been removed by now, it hasn't.

    I will be lucky if I ever make the 40% tax bracket- now go get counselling for your excessive rage and attempt to blame your predicament on anyone other than yourself.

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  • Ed Bowsher
    Love rating 80
    Ed Bowsher said

    Hi,

    In the original version of this article, I made a mistake on the tax implications of the annual allowance for pensions. I was wrong to say that the £50,000 allowance applied to net contributions when actually it applies to gross contributions. My mistake and I apologise.

    I've amended the article.

    Ed

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  • nikwilson
    Love rating 0
    nikwilson said

    Thank you Ed

    You also supposed that someone on £70k pa could get tax relief at 40% on the whole of the pension contribution of £83.33k - which again was wrong. You cannot claim back more in tax than you have paid during that tax year - basic fact.

    Sorry to pull you up on this, but the issue that a financial advisor is faced with which differs from you is that if someone had followed your advice, then there is no come back on you even though you had put incorrect information on front of potentially thousands of readers.

    As a financial journalist and specialist in this field, one could suppose that the general public would have fully trusted what you stated and would have potentially costed them alot of money had they followed this with HMRC tax charges and penalties.

    If a financial advisor had put that in writing to just one client and they had followed that advice, then the ensuing complaint may lead to an FSA investigation, claim on the advisors indemnity insurance and black mark against that advisor for getting it so wrong let alone the loss of a client and loss of face in the industry.

    I am however more suprised that an IFA did not pick this up and even more concerning is some dubious tax advice re contributions that has surfaced that has then been amended once it has been challenged. Prehaps this is down to the willingness to help and not checking, or not understanding very basic pension rules.

    I hope that if I posted grossly incorrect information on a public forum that I would be pulled up for it like anyone else.

    All I have done is my own rearsch in full untill I was sure what the rules were. A lesson for us all.

    Report on 05 December 2012  |  Love thisLove  0 loves
  • IFA
    Love rating 9
    IFA said

    Hi nikwilson,

    I haven't done the calculation based on your figures above, due to personal allowances etc... but thought a real life example might help more;

    A client earns £48,000 a year and pays a highest tax rate of 40%. She makes a personal pension contribution of £720 a month.

    Monthly payment £720

    Tax relief reclaimed by personal pension provider £180 (20% of £900)

    Total invested each month £900

    As her total yearly pensions contribution (£900.00 x 12 = £10,800) is greater than the amount of her earnings which are subject to higher rate tax, she can only claim additional tax relief on the part of her contribution which is subject to higher rate tax.

    The additional relief available to her is the difference between the two calculations below.

    Without a pension contribution: If she had made no personal pension contributions in the year, her income tax liability would have been calculated as follows:

    She would have paid tax on income above her personal allowance of £8,105

    She would have paid a basic rate tax (20%) on the next £39,895

    She would have paid a higher rate tax (40%) on any remaining income.

    Income above personal allowance = £48,000 - £8,105 = £39,895

    Income above basic rate band = £39,895 - £34,370 = £5,525

    So her tax bill would have been:

    £34,370 x 0.20 £6,874

    £5,525 x 0.40 £2,210

    Total £9,084

    With a pension contribution:

    Because she contributes a total of £10,800 to her personal pension in the year, her income tax liability will be calculated as follows:

    Her tax bands are the same except that her basic rate band is increased by the total yearly amount invested in her personal pension. So she'll pay basic rate tax on up to £34,370 + £10,800 = £45,170

    Income above personal allowance = £48,000 - £8,105 = £39,895

    The remainder is less than her revised basic rate band, so she'll pay basic rate tax on it all.

    So her tax bill will be:

    £39,895 x 0.20 £7,979

    So she can claim additional tax relief of £9,084 - £7,979 = £1,105 in her tax return.

    So her total tax relief for the year will be (£180 x 12) + £1,105 = £3,265

    Report on 05 December 2012  |  Love thisLove  0 loves
  • nikwilson
    Love rating 0
    nikwilson said

    Hi IFA

    So you agree that only part of her pension contribution will get the additional 20% relief and not the whole lot - which is what I thought and have been trying to clarify.

    I think the confusion crept in because in the original example given by Ed, he stated that the salary was £70k. And then you gave me a calculation that stated £33.33k would be the tax relief on a payment of £83.33k (40%). The error was that you missed covering the £70k salary as my question related to the example and not generic £50k/0.6 = £83.33k, and the annual allowance charge being overlooked..

    Thank you for coming back on this.

    Report on 05 December 2012  |  Love thisLove  0 loves

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