Reply to: General Pension Questions

[glashIFA@Paramount]

Whatever an IFA charges, it's to much. The only useful thing they can do is tell you which are the cheapest providers, something you can find out yourself with a little bit of surfing.

Bit harsh this - i like to think there's a bit more to my job than that!

[Bumfluff]

Being yound (under 30 - just), I'm not doing ANYTHING yet until I am completely satisfied with this country's political status. At the moment, things are so unstable and heading towards dictatorship, that a pension may end up being worthless due to predatory taxation and economic collapse.

A friend of mine keeps his cash in cut diamonds.

A quote from 2006, seems to have been right with whats happening now, can you tell me the lottery numbers for next week ?

[ASB]

I've more than likely got this completely around my neck, but I *think* where the money came from to fund the contribution to the pension doesn't have a bearing when looking at the relative difference in tax positions.

Here we go then:-

You pay 810 giving 1038 in the pension. The £1000 turns into £523 in your hand. Then you get relief back of 186.84 (I am assuming there is 38 quid of spare higher rate income from somewhere).

So the £1000 turns into 1038 in the pension and also -100 in cash (523 + 187 - 810)

The difference is thus about 14% - pretty much where we started from (or 20% if you do not have other higher reate income to get the releif from).

As you say it's persoanl choice as to the aceeptability of the risk (fwiw I had always made contributions from the company despite being outside IR35 since it was mainly pre 'A' day and I could not be bothered to change)

[minstrel]

1) Contribution from company 1000 always yields 1000
2) Contribution from self if higher rate on dividends. 1000 yields 1038 + 30 quid rebate.
3) Contribution from self if higher rate salary. 1000 yields (possibly!) what I said above.

Yes - I agree your calculations are correct if we were looking at making contributions via salary in the fist place, and that it does get more complex when we are looking at retrospective deemed salary calculations.

I've more than likely got this completely around my neck, but I *think* where the money came from to fund the contribution to the pension doesn't have a bearing when looking at the relative difference in tax positions.

All that matters is the fact that the Higher Rate threshold has been raised by £1038 and this affects the tax due on the deemed salary calculation for the additional £1000.

I'm probably reaching the limit of my knowledge now, but I think we've agreed that the position under a retrospective deemed salary calculation is going to be somewhere between -6.3% and -20.9%. Also, it would never be as large as a 20.9% loss as there is extra relief in their somewhere which hasn't been accounted for.

Again, it's all down to attitude to risk and how confident you are that you are outside IR35, but even with a worse case scenario of 20.9% loss I would still be prepared to take the risk and make the contributions personally rather than direct from company. If you are not confident that you are outside IR35 then making company contribution would be a good mitigation strategy.

[ASB]

Anyway, I'm not at all confident in my reasoning, so please shoot me down if anyone has the time/patience to work through my logic.

The 3 things we have are:-

1) Contribution from company 1000 always yields 1000
2) Contribution from self if higher rate on dividends. 1000 yields 1038 + 30 quid rebate.
3) Contribution from self if higher rate salary. 1000 yields (possibly!) what I said above.

Now, the complication in 3 is whether this is as a result of being in or out of IR35.

This should make no difference. The deemed payment is made against the normal PAYE regime and the position regarding CT is in the gift of the inspector. [He may allow the amount of CT to be offset against the PAYE or it may be necessary to resubmit the accounts to get the CT back I believe].

The problem is that we are comparing appleas and pears to a certain extent.

The fact is that 810 was paid into the pension fund - as a result of this being the net amount received. This then gets bumped up to 1038 with BR relief.

Now, in the event of it being reclassified as salary it does get a bit divergent. My example was based on paying what was actually yielded by the money, I believe that to be a fair comparison.

But, as you say the actuality is that 810 was paid. So yes that gets some extra relief. But the fact remains that in order for this to happen you would have to dip into your savings to the tune of a couple of hundred quid - since the momey has not come from the salary payment. In order to make your comparison the source if the 1038 is NOT the 1000 (less deductions) paid as salary. It is the 100 paid as salry PLUS a top of other money since that did not yied the entire payment to the pension.

Does that explain why I believe the real gap to be much bigger? You have accidentally excluded the fact that in this scenario it is necessary to top up the payment with you own money from another source.

[minstrel]

As divi (on a higher rate taxpayer) the £1k turns into £810 and then £607.50. This translates into £1038 in the pension and £31.05 in the pocket.

As salary (again higher rate) the £1 turns into £886 after er's NI and then £354 of tax and £9 ee ni. So you have only got £523 in your hand.

The £523 generates £670 in the pension. Then you get relief back of I think £121 (670 x 18%).

Ths is 27% worse than the personal payment by dividend route. (although on current form I could have gone wrong again of course).

This extra hit might make it more sensible to make company contributions - i.e. ther is a guaranteed £1k that way

When I first read this I agreed with you, but then when I gave it some more thought I realised there's quite a bit more to it.

The reason is that we're not comparing the difference between making the contribution direct from the company and personally after PAYE etc. What we need to look at is the difference between a company contribution and the additional tax that Hector would be asking us for if we failed IR35 and he was trying to claim back tax retrospectively under the deemed salary arrangement.

We can't use the £670 pension figure in your example - this is retrospective taxation on a previous tax year where our pension fund already contains the £1038.

I'll have a stab at how I think it might work...

Let's start with the baseline of the situation if we pay the contribution direct from the company - we would have £1000 in the pension. This £1000 would be excluded from deemed salary calculations so the tax liability would be nil.

Now if we had paid that same £1000 via dividends we would have ended up with £1038 in our pension, our higher rate threshold would have been raised by £1038 and Hector would be after us for PAYE tax on the £1000 revenue. For simplicity lets ignore the 5% deemed salary allowance (it probably would be cancelled out by expenses anyway).

So, £1000 turns into £886 after er's NI and then £195 tax and £9 ee NI. This gives us £682 in hand and Hector would be asking for £318 in unpaid tax.

However we've only used up £886 of our additional £1038 basic rate allowance so we have an extra £1038 - £886 = £152 which generates £27 (£152 x 18%) extra relief.

So Hector would be asking for £318 - £27 = £291. Now I think we can offset the 19% Corporation Tax that we originally paid back when we thought we were outside IR35 (it would seem unfair if we couldn't - but maybe life is unfair ).

This would mean we actually only owe Hector £291 - (£1000 x 19%) = £101.

So we have a pension fund of £1038 and owe £101 tax. This a position 6.3% down on the company contribution scenario.

What I think I'm saying now is that if you make contribution personally you gain 7%, but then if you subsequently get found inside IR35 you lose 6.3%. For some reason this is uncannily like my 50/50 choice in my previous post but for based on different logic!

Anyway, I'm not at all confident in my reasoning, so please shoot me down if anyone has the time/patience to work through my logic.

[ASB]

Gain for making contributions personally rather than via company = 7%

Loss if you were investigated and found to be outside IR35 = 14%

As divi (on a higher rate taxpayer) the £1k turns into £810 and then £607.50. This translates into £1038 in the pension and £31.05 in the pocket.

As salary (again higher rate) the £1 turns into £886 after er's NI and then £354 of tax and £9 ee ni. So you have only got £523 in your hand.

The £523 generates £670 in the pension. Then you get relief back of I think £121 (670 x 18%).

Ths is 27% worse than the personal payment by dividend route. (although on current form I could have gone wrong again of course).

This extra hit might make it more sensible to make company contributions - i.e. ther is a guaranteed £1k that way

[ASB]

Phew - thank god for that. You've no idea how intimidating it is being a newbie disagreeing with someone with 700+ posts to their name - especially as most of the time you are always right

I now have boosted confidence

[minstrel]

Thats the difference. The tax calculator I used just said "qualifying pension payments". Page 5 of the link below makes it clear to include BR relief in the amount entered

http://www.hmrc.gov.uk/helpsheets/ir330.pdf

Now you've saved me a few quid this year

Phew - thank god for that. You've no idea how intimidating it is being a newbie disagreeing with someone with 700+ posts to their name - especially as most of the time you are always right

I now have boosted confidence

[minstrel]

Of course, you don't know for certain which you are doing until the six-year period for investigation into IR35 status has passed. I would have to have only a little doubt about my IR35-exempt status before the extra security that comes from defraying a potential IR35 bill with a company contribution outweights the small advantage from making a personal contribution.

That is a good point and I would say the decision depends on how confident you are that you fall outside IR35 and your attitude to risk.

I'm not sure exactly how much worse off you would be if you were found to be inside IR35, but if we were to say it was roughly 14% (12.8% Employers NI + 1% Employees NI) then we have:

Gain for making contributions personally rather than via company = 7%

Loss if you were investigated and found to be outside IR35 = 14%

From a gambling point of view you've got to rate you chances of being investigated and found inside IR35 to be > 50% in order for it to be better to make the contribution via the company.

Given that Hector has only won 3 out of over 1000 IR35 investigations I would be fairly confident that the probability of being found inside IR35 is much less than 50%.

And this ignores the probability that you are actually chosen for investigation in the first place. What is that? 10%?

The decision definitely depends on your attitude to risk, but in my view its a no-brainer.

[ASB]

.... 3. Add £1038 to box 14.6 (Gross qualifying pension payments).

Thats the difference. The tax calculator I used just said "qualifying pension payments". Page 5 of the link below makes it clear to include BR relief in the amount entered

http://www.hmrc.gov.uk/helpsheets/ir330.pdf

Now you've saved me a few quid this year

[minstrel]

Not completely convinced since I've always managed to avoid this situation (until this year). Here is how I think the calculation would work out.

Total income = standard rate band + 810.

If no pension payment then 810+90=900 x 32.5%=292.50 - 90 credit = 202.50. Tax to pay.

If pension payment of 810 then this is given relief back to the 10% band so:-

810 x 10% = 81.00 + 90 x 32.5% = 29.25. Due = 110.25 - Relief 90.00

Due to IR 20.25, The difference arises because it is only the net dividend that gets relief not the net divi plus the tax credit :-( You end up 2.5% out of pocket.

I'm pretty confident the calculation doesn't work like you say.

The easiest way to prove it is to use the real HMRC Self Assessment Tax Return software as it does the calculation for you.

1. Create a return that puts you in higher rate tax band and make a note of the 'Total Income Tax due' figure on the 'Tax Calculation' page.

2. Add £810 to box 10.15 (Dividends received).

3. Add £1038 to box 14.6 (Gross qualifying pension payments).

4. Go back to 'Tax Calculation' page and check the 'Total Income Tax due'. You should find it is £31.05 less than in step 1.

[ASB]

ASB - I agree that it is generally best to make personal contributions, but is this the way it works for higher rate tax payers?

I thought dividends of £810 paid into a pension would generate £1038 in pension and raise higher rate threshold by the same amount (£1038).

The additional income that has been received is £900 (£810 dividends + 10% tax credit).

So, by making the contribution personally we have lifted higher rate threshold by £1038 but only increased income by £900. This gives us an additional £1038 - £900 = £138 of lower rate allowance to use up with other income. Assuming that other income is dividends this gives us £138 * 22.5% = £31.05 additional relief.

In other words, for a high rate tax payer you actually gain relief, rather than losing it as you suggest.

So, £1000 company revenue paid into pension by company gives £1000 in the pension.

£1000 company revenue paid to a high rate tax payer via dividends gives £1038 in the pension + £31.05 tax credit. In effect a 7% bonus.

Not completely convinced since I've always managed to avoid this situation (until this year). Here is how I think the calculation would work out.

Total income = standard rate band + 810.

If no pension payment then 810+90=900 x 32.5%=292.50 - 90 credit = 202.50. Tax to pay.

If pension payment of 810 then this is given relief back to the 10% band so:-

810 x 10% = 81.00 + 90 x 32.5% = 29.25. Due = 110.25 - Relief 90.00

Due to IR 20.25, The difference arises because it is only the net dividend that gets relief not the net divi plus the tax credit :-( You end up 2.5% out of pocket.

[IR35 Avoider]

If you are paying dividends then it is probably better to make personal contributions.

If you are paying salary (e.g. in IR35) then it is more effective for the company to pay the contributions

Of course, you don't know for certain which you are doing until the six-year period for investigation into IR35 status has passed. I would have to have only a little doubt about my IR35-exempt status before the extra security that comes from defraying a potential IR35 bill with a company contribution outweights the small advantage from making a personal contribution.

[minstrel]

Divis = £810. Higher Rate IT = £202.50. Pension payment = 810.00 as above. Hirgher rate relifef = 810 * 22.5% = 182.25. In effect you lose 20.50 of relief.

ASB - I agree that it is generally best to make personal contributions, but is this the way it works for higher rate tax payers?

I thought dividends of £810 paid into a pension would generate £1038 in pension and raise higher rate threshold by the same amount (£1038).

The additional income that has been received is £900 (£810 dividends + 10% tax credit).

So, by making the contribution personally we have lifted higher rate threshold by £1038 but only increased income by £900. This gives us an additional £1038 - £900 = £138 of lower rate allowance to use up with other income. Assuming that other income is dividends this gives us £138 * 22.5% = £31.05 additional relief.

In other words, for a high rate tax payer you actually gain relief, rather than losing it as you suggest.

So, £1000 company revenue paid into pension by company gives £1000 in the pension.

£1000 company revenue paid to a high rate tax payer via dividends gives £1038 in the pension + £31.05 tax credit. In effect a 7% bonus.