A dumb question about income tax bands

[psychocandy]

Hi d000hg,

The above is correct.

Another point worth noting is that the basic rate band is increased by the gross value of any pension/charity contributions made personally. This is important to know for contractors who extract the majority of their income in the form of dividends, as many cap their earnings at £42,475 not realising there are further dividends available before paying additional taxes. Be careful how much you contribute though as relief is only allowed up to the value of your relevant earnings (salary, BIK etc.), it is easy for this to be overlooked if paying a small salary and the remainder of your income as dividends.

Pension contributions can be even more tax advantageous if your income falls between £100,000 and £116,210 (£100k + 2xPA) as they are deductible for the purpose of calculating your personal allowance. The effective rate of tax saved by making pension contributions can therefore be as high as 60%!

I hope this helps.
Martin

Understand that if you contribute £5K personally into a pension, in effect, you get £5K more of an allowance.

But, surely, its the same as just paying that £5K direct as a company contribution anyway (instead of as a dividend) into pension anyway? Also, company contribution is not restricted to max level of salary (which for some of us is £7K odd a year).

Or am I missing something?

[Martin at NixonWilliams]

My brain hurts on that last bit. I have to have incurred the amount of personal tax that the charity wants to claim back as Gift Aid... OK this makes sense. However fairly typically as a contractor, I arrange things so my SATR bill is £0 (other than student loan payments). But then you're saying the 10% tax which I never actually pay on dividends still counts?

Did I get that right... it sounds like roughly speaking if I give 10% of my dividends to charity, this 'cancels out' the 10% dividend tax rather neatly without me having to think about things?

Side question - who is responsible for working out what Gift Aid can be claimed back? Me, the charity, or HMRC? The charity holds a form I completed in order to claim GA, would that mean HMRC handles it based on my tax returns?


Oh - and thanks!

Yes, the 10% tax on the dividend does count as tax paid. However, what you are looking to achieve is that the dividend tax is equal to the relief obtained on the charity contribution. For example, a £10,000 contribution (net) would attract relief of £2,500. Dividends of £25,000 would need to be declared in order for this to be claimable in full as the 10% tax 'suffered' would also be £2,500.

The charity would automatically claim 20%, any further relief you are entitled to would be given when completing your self-assessment tax return as there is a box to be completed for contributions falling under gift aid.

I hope this helps.

Martin

[Martin at NixonWilliams]

Understand that if you contribute £5K personally into a pension, in effect, you get £5K more of an allowance.

But, surely, its the same as just paying that £5K direct as a company contribution anyway (instead of as a dividend) into pension anyway? Also, company contribution is not restricted to max level of salary (which for some of us is £7K odd a year).

Or am I missing something?

Hi psychocandy,

In a lot of cases the savings when paying personally vs. through a company are neutral. However, for higher rate taxpayers it is generally advisable to make the contributions personally up to the value of the salary paid and then the remainder through the company - though the savings when adopting this method are often quite small. See the below illustration of how this method can be beneficial:

A company contribution of £10,000 attracts 20% relief and therefore effectively costs the company £8,000.

If done personally, a dividend of £8,000 would be declared and would be paid into the pension scheme, making a gross contribution of £10,000.

Assuming you have already taken dividends up to the higher rate threshold, the personal contribution extends your basic rate band by £10,000 - this allows you to take a further £1,800 in dividends (net) without incurring additional taxes.

I hope this helps, if I can help further feel free to ask!

Martin

[psychocandy]

A company contribution of £10,000 attracts 20% relief and therefore effectively costs the company £8,000.

If done personally, a dividend of £8,000 would be declared and would be paid into the pension scheme, making a gross contribution of £10,000.

Assuming you have already taken dividends up to the higher rate threshold, the personal contribution extends your basic rate band by £8,888 - this allows you to take a further £888 in dividends without incurring additional taxes.

I hope this helps, if I can help further feel free to ask!

Martin

Hi Martin,

Still think I'm a bit dull here...Never understood this pension idea.

OK. Understand the first two bits.

So you've got another £888 to play with?

OK. Up to tax limit already. Declare £8K dividend, bung it all into pension - becomes £10K. Then declare another dividend of £800 (grossed up = £888). No further personal tax to pay. If I hadnt made this £8000 pension contribution previously it would cost 22.5% i.e. £180 in extra tax. Correct?

Guess it only matters if you're close to the limit anyway? With me - I income split with the dear wife so, because of her own job (£12K), shes always closer to £42K than me (£7K income).

[SimonMac]

I typed it, deleted it, typed it again, deleted it again - goes against my nature to be mean! I had to channel a bit of NLUK to manage it

So you were a female version of NLUK? Maybe even a NLyUK?

[Martin at NixonWilliams]

Hi Martin,

Still think I'm a bit dull here...Never understood this pension idea.

OK. Understand the first two bits.

So you've got another £888 to play with?

OK. Up to tax limit already. Declare £8K dividend, bung it all into pension - becomes £10K. Then declare another dividend of £800 (grossed up = £888). No further personal tax to pay. If I hadnt made this £8000 pension contribution previously it would cost 22.5% i.e. £180 in extra tax. Correct?

Guess it only matters if you're close to the limit anyway? With me - I income split with the dear wife so, because of her own job (£12K), shes always closer to £42K than me (£7K income).

Hi psychocandy,

That is correct - In the above example it would be the tax saving of £180 that you could possibly benefit from.

You are also correct in saying that the effects will generally be neutral for basic rate taxpayers.

Martin

[d000hg]

That ended up being far less dumb a question than I thought

Thanks for the replies!

[ASB]

Hi psychocandy,

That is correct - In the above example it would be the tax saving of £180 that you could possibly benefit from.

You are also correct in saying that the effects will generally be neutral for basic rate taxpayers.

Martin

Is this a good time to mention the NI implications since in order to make personal contributions there has to be relevant salary and that can cause a certain amount of issue as to overall salary levels v dividends in order to screw the last penny out of the system when comparing to the possibility of corporate pension contributions.

Getting the absolute best mix of salary, dividend, personal pension contributions and corporate contributions can be a fine art.

[Waldorf]

Getting the absolute best mix of salary, dividend, personal pension contributions and corporate contributions can be a fine art.

Very true.

I just take a simple process, I take a salary of £7488, utilise reasonable expenses and take the rest in dividends, leaving a small pot within the company.

I don't do pensions, I fully invest in an isa each year and make some modest charity contributions.

Keep it simple, less worries and I can sleep at night.

[d000hg]

Why do many accountants recommend taking a salary of personal allowance - £500 or so, rather than exactly the personal allowance?