Pensions have always been one of the most tax-efficient ways to save for the future, although recent changes have made them less appealing for higher rate taxpayers.
Saving for Retirement
To spur people on to save towards retirement, the government automatically gives tax relief of 20% on any pension contributions you make. If you’re a higher or top-rate taxpayer, you can reclaim an extra 20% or 25% through your self-assessment tax return. That means a £10,000 pension contribution can cost you just £6,000 if you’re a higher rate taxpayer, or £5,000 if you’re a top rate taxpayer.
Pension Tax Relief and your Annual Allowance
However, there’s a maximum £40,000 annual allowance which applies your pension contributions each tax year. You won’t receive rate relief on any contributions you make over the £40,000 threshold.
Under changes announced in the 2015 summer budget, pension tax relief is progressively reduced for those earning £150,000 or more. From April 2015, it will be reduced at a rate of £1 for every £2 earned over £150,000. This means that the tax allowance for those earning over £210,000 putting money into pensions will be cut to £10,000.
This tapering of tax relief on pensions may mean that high earners may be better off exploring alternative tax-efficient investments such as those outlined below.
Pension Tax Relief Calculator
Your Pension Tax Relief Result
Pension tax relief means only a proportion of your desired pension contribution will have to come out of your own pocket ('Net Pension Contribution'). The remainder is topped up by the government in the form of tax relief to form your total 'gross' pension contribution. Below we've calculated how much you'll have to pay into your pension to receive a government top-up that will equal your desired total gross contribution this tax year.
20% Tax Relief Added at Source
The government automatically adds 20% tax relief to pension contributions within your annual allowance.
Get More For Your Money Through Your Tax Return
As you're a higher rate (40%) taxpayer, you can reclaim additional pension tax relief through your tax return. The government automatically adds basic rate (20%) tax relief to all pension contributions at the source. The remaining tax relief is reclaimed through your tax return.
As you're an additional (45%) taxpayer, you can reclaim additional pension tax relief through your tax return. The government automatically adds basic rate (20%) tax relief to all pension contributions at the source. The remaining tax relief is reclaimed through your tax return and may be made up of a combination of additional rate tax relief and reclaimed income tax personal allowance.
How this calculator works...
Drewberry has calculated the tax relief you may be able to receive based on you being a 0% taxpayer, a basic rate (20%) taxpayer, a higher (40%) taxpayer or an additional (45%) taxpayer in the 2017/18 tax year.
We've also calculated the benefit to you based on the fact that you may regain some of your lost income tax personal allowance by making pension contributions if you earn between £100,000 and £123,000. However, there are many other factors that may affect your eligibility for tax relief on your pension contributions, including your age – for example, tax relief on pension contributions stops once you reach the age of 75.
These calculators help but sometimes it doesn't beat talking to a human. If you
need any support please do not hesitate to pop us a call on 02084327333.
Head of Pensions Advice at Drewberry
Individual Savings Account (ISA)
Individual savings accounts (ISAs) are a form of tax-free savings account where returns are free from income tax and capital gains tax. This tax year (2015/16) you can invest up to £15,240 into ISAs, either into stocks and shares, or into cash, or a combination of the two. Cash ISAs tend to suit those who are very risk averse, or who are only investing over a very short time-frame.
Stocks & Shares ISA
Those who are investing over the long term, and who are prepared to accept a level of risk in return higher potential returns, should look to build a balanced portfolio of investments. An adviser will be able to recommend the right mix of investment to suit your risk profile and investment objectives. You can either invest in individual funds directly with a fund manager or managers, or you can use a fund supermarket to mix a wide range of funds within a single ISA.
Venture Capital Trust (VCT)
A Venture Capital Trust (VCT) is a company which invests in very small, fledgling companies and whose shares are traded on the stock market. They aren’t for the faint-hearted as the companies invested in are only just getting going, and not all of them will succeed. VCT shares can also be hard to sell, so you may get back less than you put in.
Tax relief on VCTs
There are significant tax benefits offered to VCT investors, with income tax relief given at 30% on annual contributions of up to £200,000. That means, for example, that if you invest £10,000, you’ll get £3,000 back from the taxman. You only get to keep this tax rebate if you hold your VCT shares for at least five years.
There is also no tax on gains, regardless of how long you hold the VCT, as well as no income tax to pay on dividends. This is likely to be particularly attractive to high earners given changes to the way dividends are taxed announced in the summer budget. These changes mean that from next year those receiving more than £5,000 in dividend income outside an ISA will pay more tax.
However, despite all the tax benefits of VCTs, they will only be suitable for a minority of investors due to the risks involved, so always get professional advice before you invest.
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Enterprise Investment Scheme (EIS)
There are several tax incentives for higher rate taxpayers who invest in small, unquoted companies via the Enterprise Investment Scheme (EIS).
The EIS was launched in 1994, to encourage people to invest in small companies.
When you make your initial investment, which you usually make directly in a qualifying company, you receive income tax relief at 30% of the cost of the shares. For example, if you invest £10,000, you can reduce your income tax by £3,000 that year. You can also “carry back” this relief to help reduce your income tax liability in the previous year.
There’s also no capital gains tax to pay on any profits you make from an EIS investment. If your investment performs badly and you make a loss, you can offset that loss against income tax. You must hold EIS investments for a minimum of three years in order to qualify for this income tax relief.
You will, however, have to pay tax on any dividends you receive.
The maximum amount you can invest in any one company is £1m, and there is no minimum. Investing in EISs usually requires you tying up your money for a long period of time, so they won’t suit you if you need access to your savings.
Seed Enterprise Investment Scheme (SEIS)
The Seed Enterprise Investment Scheme (SEIS) was introduced in 2012. It works in a similar way to EIS, except you invest in even smaller start-up companies. These are particularly high-risk, so investors are offered even more generous tax breaks.
You receive income tax relief at 50% rather than 30%, which means for every £10,000 you invest, you can deduct £5,000 off your income tax bill. There is no capital gains tax to pay and as with EIS, you can offset any losses against tax too.
There are other capital gains tax benefits too. If you’ve recently had to pay capital gains tax on other investment, you can reclaim up to 50% of this tax as long as you reinvest the money into SEIS.
The maximum you can invest though SEIS in any one tax year is £100,000.
Seek Financial Advice from our Experts
A professional pensions adviser will be able to advise you and guide you through the process. If you would like to discuss your pension options you can contact us directly on 020 8432 7333, we have a team of dedicated experts who are no hand to provide a 5 star service and ensure you have all the information you need to make an informed decision.