Question
Next tax year I have to sell stock options that will mean I make a capital gain of £40K, ( I've already used my CGT allowance for 2011/12 ). This means I will be liable for CGT on circa £30K. I am a 40% tax payer with a threshold of £35K for 2012/13. If I invest enough of my salary into my pension to ensure I'm just below my £35K lower rate tax limit I assume I'll only be liable for CGT at 18% as opposed to 28%. Am I correct ? Answer
You're correct that pension contributions can help reduce your income into the basic rate tax band. But capital gains are then added to this to calculate the proportion of the gain that's taxed at 18% and 28%.
So, in your example: After deducting your annual personal income tax allowance the basic rate tax threshold is £35,000. Your capital gain of £40,000, less the annual allowance of £10,600, will be added to your income with the proportion falling below £35,000 being taxed at 18% and the remainder at 28%.
Let's suppose your income, after deducting your income tax personal allowance, is £42,000. Without a pension contribution the full £29,400 (£40,000 - £10,600) taxable gain will be taxed at 28%, landing you with a £8,232 tax bill.
If you make a £10,000 pension contribution your taxable income will fall to £32,000. So the first £3,000 of the £29,400 taxable gain will fall within the basic rate band hence be taxed at 18%, while the £26,400 balance will still be taxed at 28%. This reduces the tax bill to £7.932.
So while it's possible to make a difference, you'll need a very large pension contribution to make a significant difference.
Hope this makes sense.
Next tax year I have to sell stock options that will mean I make a capital gain of £40K, ( I've already used my CGT allowance for 2011/12 ). This means I will be liable for CGT on circa £30K. I am a 40% tax payer with a threshold of £35K for 2012/13. If I invest enough of my salary into my pension to ensure I'm just below my £35K lower rate tax limit I assume I'll only be liable for CGT at 18% as opposed to 28%. Am I correct ? Answer
You're correct that pension contributions can help reduce your income into the basic rate tax band. But capital gains are then added to this to calculate the proportion of the gain that's taxed at 18% and 28%.
So, in your example: After deducting your annual personal income tax allowance the basic rate tax threshold is £35,000. Your capital gain of £40,000, less the annual allowance of £10,600, will be added to your income with the proportion falling below £35,000 being taxed at 18% and the remainder at 28%.
Let's suppose your income, after deducting your income tax personal allowance, is £42,000. Without a pension contribution the full £29,400 (£40,000 - £10,600) taxable gain will be taxed at 28%, landing you with a £8,232 tax bill.
If you make a £10,000 pension contribution your taxable income will fall to £32,000. So the first £3,000 of the £29,400 taxable gain will fall within the basic rate band hence be taxed at 18%, while the £26,400 balance will still be taxed at 28%. This reduces the tax bill to £7.932.
So while it's possible to make a difference, you'll need a very large pension contribution to make a significant difference.
Hope this makes sense.
Read this Q and A at http://www.candidmoney.com/questions/question679.aspx
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