Investing, Pensions and Finance
Can your pension help you escape a tax trap?
Pensions aren’t just about securing an income in retirement; they can also help you avoid some common tax traps. We’ve outlined a few below for you to think about.
Beating the Child Benefit Tax charge
Child Benefit can be a valuable addition to the family income. Currently worth £1,331 a year for those with one eligible child, £2,212 for two and £3,094 for those with three. In 2013, the Government introduced a new tax designed to claw back this benefit from those deemed to have a ‘high income’.
If you claim Child Benefit and you or your partner, who you live with, have an income over £60,000, for every £200 of income over this amount you repay 1% of your Child Benefit. This means that if you have an income of £70,000 you would need to repay 50% of your Child Benefit, at £80,000 or more you would need to repay all of it. If you live with a partner, spouse or civil partner the tax is assessed on and is payable by, the person with the higher income, regardless of who receives the Child Benefit.
The good news is that it’s your income after payments into a pension that’s used to determine if you need to repay some, or all the Child Benefit you or your partner receive.
As an example, someone with three children and an income of £70,000 would normally repay 50% of their Child Benefit (£1,547). By paying £8,000 into a pension, to which HMRC would add a further £2,000 they would reduce their income by £10,000 to £60,000 and retain all their Child Benefit. In addition, they could reclaim another £2,000 in tax via their tax return.
The result would be £10,000 in their pension fund and a tax saving of £5,547.
Taking the sting out of becoming a 40% taxpayer
Once your income rises above £50,270 you begin to pay 40% tax on your earnings or profits above this threshold. Earning just £1 over this amount means you also lose other valuable tax benefits. This includes the amount of tax-free interest you can receive on your savings each tax year, which would drop from £1,000 to £500. You also lose the ability to benefit from the Marriage Allowance which allows a non-tax paying spouse or civil partner to transfer part of their tax-free personal allowance to you and can be worth up to £252 in the current tax year.
The £50,270 threshold from which 40% Income Tax becomes payable hasn’t changed since April 2021, as incomes and wages rise, an increasing number of people are being caught in the 40% tax net.
Making full use of your ISA allowance each tax year becomes increasingly important as any income or gains they generate are free from tax. Similarly, pensions can also play an important role in reducing your overall tax bill and restoring lost allowances.
Avoiding the 60% tax charge
It’s the ambition of many to reach an income of £100,000, but it does come with an unexpected sting in the tail.
For every £2 of income over £100,000 you lose £1 of your tax-free personal allowance of £12,570. This means that any earnings between £100,000 and £125,140 are effectively taxed at 60%. When you add on the 2% National Insurance payable that means you only keep £38 of every £100 earned.
One of the most effective ways to get out of this tax trap is to invest in your pension. If you are an employee ‘salary sacrifice’ can be very tax efficient for both you and your employer.
As an example, an employee with earnings of £125,140 who chose to give up £25,140 of salary in return for an employer pension contribution of the same amount, would save £15,084 in Income Tax (60%) and 2% in National Insurance (£502). This means they would have £25,140 going into their pension at a cost to them of £9,554.
Their employer would also escape Employer’s National Insurance on the money they pay into the pension, saving them 13.8% or £3,469. With Employer’s National Insurance due to rise to 15% from April 2025 this will increase the benefits of salary sacrifice for employers.
The value of investments can rise or fall, and you may get back less than invested.
The tax treatment of pensions and ISAs depends on individual circumstances and may change in the future.
NFU Mutual Financial Advisers advise on NFU Mutual products and selected products from specialist providers. They’ll explain the advice services and the charges. Financial advice is provided by NFU Mutual Select Investments Ltd.
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