Save on your income tax by paying into your pension pot? Sounds too good to be true? Well it’s not and tax law here in Scotland allow those in a higher tax band to save on income tax by paying into their pension. Read on to find out more:
Current Scottish income tax brackets fall as follows:
|Up to £12,570
|£12,571 to £14,732
|£14,733 to £25,688
|£25,689 to £43,662
|£43,663 to £150,000
Assuming the standard personal allowance remains at £12570, paying into your pension could allow your income to fall to a lower taxable bracket and therefore reduce your tax responsibilities. Once any pension contribution is removed, your tax obligations are calculated by your “adjusted net income” and reducing your income with a pension investment is an ideal way to save on your eventual tax bill.
Another one of the basic facts to remember is that a pension contribution for people earning between £100,000 and £125,140 could theoretically give you an effective tax relief rate of 61.5%. The tax-free personal allowance reduces by £1 for every £2 your adjusted net income exceeds £100,000. It is nil once your income exceeds £125,140.
Although income that falls within the higher rate band is taxed at 41%, the personal allowance taper means some of your income could effectively be taxed at a staggering 61.5%. As an example, image you earn a £100,000 salary and are awarded a £1,000 bonus. Not only would you pay £410 in tax on the additional £1,000, but you would also lose £500 of your personal allowance. This extra £500 would also be taxed at 41%, costing you another £205. As a result, earning that extra £1,000 would cost you £615 in tax, which equates effectively to a 61.5% tax rate.
The best way to mitigate this? Pay into your pension. If you made a gross pension contribution of £1,000, your adjusted net income would fall to £100,000, thereby reinstating your personal allowance and giving you the equivalent of an effective rate of tax relief of 61.5% on your contribution.
You should consult a professional advisor for more details, however, and you should be aware of the annual pension allowance cap or the lifetime allowance when calculating your best approach to mitigating your financial responsibilities.
It can be a minefield to navigate so do get in touch so that we can help you find the right path for your circumstances.