Question
For high earners, how is income calculated when determining whether an income taxpayer loses their personal allowance in the 2011-12 tax year? For example, if you earn £140,000 and make a £40,000 pension contribution, is one's income considered to be £140,000 or £100,000 for personal allowance purposes? In other words, is it worth making a big pension contribution (subject to the £50,000 annual limit) in order to avoid the very high effective marginal rate of income tax on incomes in the low £100,000s?
P.S. Great site.Answer
Pension contributions are deducted from your income, allowing you to potentially reclaim your personal allowance when earning above £100,000 (the £6,475 personal allowance is reduced by £1 for every £ 2 earned above £100,000).
So, in your example of a £40,000 pension contribution when earning £140,000:
A £40,000 pension contribution would initially cost you £32,000 - as the contribution automatically enjoys basic rate tax relief.
You can then reclaim higher rate tax relief via your tax return (or, in some instances, PAYE). This equates to a further £8,000, meaning the £40,000 contribution has effectively cost you £24,000.
However, you can also reclaim the lost personal allowance as your income has now been reduced to £100,000. This equals an extra £2,590, calculated as 40% of your £6,475 personal allowance (i.e. the tax that would otherwise been paid on this amount).
This means your £40,000 pension contribution ends up costing £21,410 after tax relief. Putting this another way, pension contributions from income between £100,000 and £112,950 effectively enjoy 60% tax relief.
I've used the 2010/11 personal income tax allowance, but the concept remains unchanged for the next tax year (you'll just get more tax relief from the £7,475 allowance).
Just a word of warning on contributions made before 6 April 2011. If your income exceeds £130,000 you may not benefit from higher rate tax relief on pension contributions, see our pension rules page for more info. From next tax year pension contributions are unaffected by earnings, but a flat £50,000 annual contribution limit will apply.
Glad you like the site!
For high earners, how is income calculated when determining whether an income taxpayer loses their personal allowance in the 2011-12 tax year? For example, if you earn £140,000 and make a £40,000 pension contribution, is one's income considered to be £140,000 or £100,000 for personal allowance purposes? In other words, is it worth making a big pension contribution (subject to the £50,000 annual limit) in order to avoid the very high effective marginal rate of income tax on incomes in the low £100,000s?
P.S. Great site.Answer
Pension contributions are deducted from your income, allowing you to potentially reclaim your personal allowance when earning above £100,000 (the £6,475 personal allowance is reduced by £1 for every £ 2 earned above £100,000).
So, in your example of a £40,000 pension contribution when earning £140,000:
A £40,000 pension contribution would initially cost you £32,000 - as the contribution automatically enjoys basic rate tax relief.
You can then reclaim higher rate tax relief via your tax return (or, in some instances, PAYE). This equates to a further £8,000, meaning the £40,000 contribution has effectively cost you £24,000.
However, you can also reclaim the lost personal allowance as your income has now been reduced to £100,000. This equals an extra £2,590, calculated as 40% of your £6,475 personal allowance (i.e. the tax that would otherwise been paid on this amount).
This means your £40,000 pension contribution ends up costing £21,410 after tax relief. Putting this another way, pension contributions from income between £100,000 and £112,950 effectively enjoy 60% tax relief.
I've used the 2010/11 personal income tax allowance, but the concept remains unchanged for the next tax year (you'll just get more tax relief from the £7,475 allowance).
Just a word of warning on contributions made before 6 April 2011. If your income exceeds £130,000 you may not benefit from higher rate tax relief on pension contributions, see our pension rules page for more info. From next tax year pension contributions are unaffected by earnings, but a flat £50,000 annual contribution limit will apply.
Glad you like the site!
Read this Q and A at http://www.candidmoney.com/questions/question440.aspx
No comments:
Post a Comment