Despite constant tinkering with pensions legislation Neil MacGillivray believes there are still opportunities.
At the time of writing this article, prior to George Osborne's pre-budget statement; I am reminded of my childhood and my Christmas wish lists. Despite repeated requests for a Hornby 00 gauge train set, Santa never came up with the goods (train), and so it is with the Treasury; despite many a wish to stop tinkering with pension legislation, they continue to fail to live up to my expectations!
Despite this, I still firmly believe there is a place for pension saving in any taxpayer's financial planning, and in particular where the individual is a higher rate taxpayer. As HMRC continues to look at ways of increasing the tax take, it becomes even more important to ensure individuals shelter as much of their income as possible.
From 7 January we will see the introduction of the new child benefit income tax charge (CBITC) for those families in receipt of child benefit, and where any person has ‘adjusted net income' in excess of £50,000 they will lose £1 (through the tax charge) for every £100 earned over this threshold.
‘Adjusted net income' is basically total income subject to tax, less trading losses, gross gift aid donations and all grossed up individual pension contributions. Thus, for those caught by the CBITC, they could consider funding their pension to minimise this tax. Where the person has two children, is in receipt of child benefit for both of them, and also has an income of £60,000, a gross pension contribution of £10,000 will in effect receive tax relief at 57.52%.
Another important client segment where consideration needs to be given to pension planning is for those individuals with ‘adjusted net income' between £100,000 and £116,120. Those falling into this segment will lose £1 of their personal allowance for every £2 over the threshold, which is equivalent to paying a marginal rate of tax of 60%.
As before, the threshold figure is the ‘adjusted net income', and so any pension savings will result in the individual clawing back at least part, if not all, of their personal allowance. The ideal scenario is to make pension savings equal to the amount of ‘adjusted net income' over the threshold, thereby in effect gaining tax relief at 60% on the whole contribution.
The final client segment I wish to highlight is those clients who fall into the additional rate tax bracket segment. For these individuals, there are a number of considerations which should be taken into account. In the first instance, their current marginal rate of income tax is 50% whereas from next tax year this will fall to 45% and presuming of course that the Chancellor retains higher rate relief, any personal pension contributions made by them in the current tax year will receive relief at the higher level.
In a scenario where the individual is able to make a sizeable pension contribution, can satisfy the flexible drawdown criteria and is in a position to take benefits in the 2013/14 tax year, then a potentially interesting proposition also arises.
Presuming they receive marginal rate relief at 50%, they have no annual allowance charge to pay, as carry forward is available and the contribution is not caught by the recycling legislation, then a potential net return of 40% could be achieved in a very short period of time. Making a net contribution of £50,000 (gross £100,000) and then taking the pension commencement lump sum and the remaining fund through flexible drawdown next tax year (£45,000 for a 40% tax payer next year), the net return is £70,000, a 40% uplift on the net contribution of £50,000, or 32.5% for a 45% tax payer.
There are still beneficial tax outcomes for those prepared to fund their pensions, as evidenced above, not to mention the fact that funds held in a pension are in a tax advantageous environment, all of which I believe justifies the continuing use of pensions in any holistic financial plan. And for those concerned about my mental well being, having failed to receive a train set in my youth; I am happy to confirm I have an extensive train layout permanently set up in the garage .... now, if only the Chancellor would listen to my wish lists!
Neil MacGillivray is head of technical support at James Hay Partnership
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