Tax benefits of investing in a pension
Would you like to invest in property whilst getting a tax rebate?
Would you like to build and control your pension pot?
I am going to demonstrate the tax advantages of investing into a pension fund that still allows you to invest in property. Albeit the properties you will be allowed to invest into will be commercial in nature.
The types of commercial properties that will be allowed to be invested into by your SIPP pensions are:
- Serviced apartments
- Bed & Breakfasts
- Holiday Lettings
Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read Here for more (opens in a new tab)
Employer pension contributions
Did you know that your employer (also your own business) can pay into a pension on your behalf? Not only can you personally pay into a pension and benefit from a tax relief but your company can to. As an additional bonus the pensions contribution that the company makes is also tax allowable. (2)
A new law means that every employer must automatically enrol workers into a workplace pension scheme if they:
- are aged between 22 and State Pension age
- earn more than £10,000 a year
- work in the UK
This is called ‘automatic enrolment’.
Usually your employer takes the pension contributions from your pay before deducting tax (but not National Insurance contributions). You only pay tax on what’s left. So whether you pay tax at basic, higher or additional rate you get the full relief straightaway.
If your employer can’t deduct your pension contributions from your pay you can still get tax relief. You’ll need to claim the tax relief you’re due through your tax return, or if you don’t complete a tax return by contacting HM Revenue & Customs (HMRC).
However, some employers use the same method of paying pension contributions that personal pension scheme payers use – read more in the section on ‘Personal pensions’.(6)
Many employers have either a company pension scheme that they’ve set up for their employees or provide access to a group personal scheme. Your employer will also contribute towards your pension.
From October 2012 employers had to start enrolling their employees into a pension scheme and pay contributions for them (7).
How much you can invest in a pension
The amount of your pension savings that benefits from tax relief is limited to an annual allowance, currently £40,000 as long as the below is in place:
- a registered pension scheme
- an overseas pension scheme – as long as either you or your employer qualify for UK tax relief on those pension savings
If you save more than this amount you may have to pay a tax charge on the excess.
You can carry forward any unused annual allowance from the last three tax years to the current tax year so you might not have to pay the annual allowance charge. Therefore you can invest £120,000 on the first investment.
If your pension savings are more than the total of the annual allowance and your unused allowance you’ll pay a tax charge on the excess.
You’re responsible for paying the annual allowance charge. In certain circumstances you can ask your scheme administrator to pay the tax out of your pension pot.
Depending on what type of pension scheme you’re in, working out how much annual allowance you’ve used or can carry forward and how much tax you have to pay can be complicated.
The tax rate that’s charged depends on any other taxable income you have. The amount of your pension savings that exceed your annual allowance is added to any other taxable income for that tax year. After your allowable expenses and any tax-free allowances have been taken into account, the amount of tax you pay is calculated using different tax rates and a series of tax bands.
Pension contributions limited to £10,000
Whilst the above was a very nice way to invest and get tax relief, the government have decided to stop people benefitting from the tax relief by investing in their future, as can be seen from their website.
The amount of money that you can invest in a pension now drops from £40,000 for every £2 you earn over £150,000. If you earn £160,000, then this is £10,000 over the £150,000 rate.
This means that the pension contribution allowance is reduced by £5,000.
This person could now contribute £35,000 into their pension and get tax relief on it.
If you earn more than £210,000, then the maximum amount of money that you can invest in a pension is limited to £10,000. Our specialist tax advisers can assist you further in discussing your wealth planning.
Download your buy to let tax guide here, written by our property accountants
Saving your Child Benefits by contributing towards a pension
If you are an employee and you have a offspring then you may be aware that you can claim child benefit from the government. The amount that you can claim is:
- £20.70 per week for the first child
- £13.70 per week for each child thereafter
You normally qualify for Child Benefit if you’re responsible for a child under 16 (or under 20 if they stay in approved education or training) and you live in the UK.
If you have not done so already you can make a claim by using this link.
You may also be aware that child benefits are reduced if you or your spouse earn more than £50,000. Any excess of the £50,000 will be charged against the child benefit that you have received. This tax charge will be taken via your self-assessment as part of the work we do for our clients.
Earned salary less £50,000:
——————————— (% result) X Child Benefit Received
Someone earning £55,000 would therefore have a tax charge of:
50% = £5,000 (£55,000 less £50,000) divided by 100
£538.20 = 50% (above) £1,076.40 (52 weeks X £20.70).
If the employee in question had invested £3,000 into the pensions he and the employer would have received the following savings:
- £60 – 2% employee national insurance contributions at the high rate tax band
- £1,200 – 40% income tax relief
- £538.20 child benefit tax charge avoidance as they now earn the limit of £50,000
- £1,798.20 total savings
If we also considered the employer’s savings we would see total benefits of:
- £1,798.20 Employee savings: income tax, national insurance and child benefit tax charge avoided
- £414 employers national insurance savings (13.8% X £3,000)
- £2,212.20 total savings enjoyed by the employer and employee
The savings of £2,122.20 is now 73.7% of the £3,000 originally invested.
Pitfalls of pension contributions
It is possible that an employer may have made £40,000 pension contributions on the behalf of the employee. However, without both the employee or employer knowing that the level of contributions has exceeded the annual allowances. In this case, we will assume that the employee is a high rate tax payer. The £10,000 excess will then have a £4,000 (40%) tax charge.
It can get much worse, without the right tax advice and wealth planning professional inputs. Let’s assume that an employee draws down some of his pension to get 25% tax relief and starts to take the pension benefits annually. This would reduce their pension contribution annual allowances from £40,000 to £10,000 based on the governments website known as Money Purchase Annual Allowance (MPAA).
If we now look back and see that the £40,000 pension contributions exceeds the £10,000 by £30,000. As such, the employee will then have to pay tax of £12,000 (£30,000 x 40%).
You need to be mindful of:
- What your annual allowances are for pension contributions
- Who make the contributions
- Who gets the tax relief
If you are a business owner, it provides additional benefits:
- Gets money out of the limited company in a tax-efficient way
- The above reduces the overall value of the business from an inheritance tax perspective
- You do not need to increase your salary costs to make the pension contributions, which would incur national insurance costs for both the employee and employer