This trick won’t be for everyone but it does show the value of keeping a close eye on ‘marginal’ tax rates – and how contributing to a pension can help save huge amounts of tax.
A great example of a marginal tax rate is seen on earnings between £100,000 and £123,000. At this level of income you’re already a higher rate tax payer so can expect to pay 40% in tax. On this level of income you also lose your personal allowance (that’s the bit you can earn without paying tax). You lose £1 of personal allowance for every £2 over £100k you earn. That means the marginal rate of tax on earnings between £100,000 and £123,000 are taxed at a whopping marginal rate of 60%.
Now imagine if you made a net pension contribution of £18,400. This would be grossed up by the Government so your pension would receive £23,000 in total. You’d get higher rate tax relief of £4,600 and save another £4,600 in tax as you would have retained your personal allowance.
Doing the maths you’ve spent £18,400 of cash going into your pension and saved £9,200 in tax right away. That means your net outlay is £9,200 to get £23,000 in your pension. That’s an instant guaranteed return of 150%!
There is a similar marginal rate between £50,000 and £60,000 for people with children claiming the Child Benefit allowance and Child Benefit is clawed back.
And it’s still a positive move for anyone paying 40% in tax. The net cost of putting £1,000 into your pension is £600 – still an impressive 67% return.
A disclaimer – everyone’s circumstances are different so you’ll need to take the advice of an IFA before investing into a pension.
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