Example showing the benefits of a pension contribution which reduces a client’s adjusted net income to £100,000
Stephen who lives in Manchester has net income of £120,000. If he pays a pension contribution of £20,000 gross then his adjusted net income for personal allowance purposes will be £100,000.
Without a pension contribution Stephen's personal allowance is £2,500 and taxable income after personal allowance is therefore £117,500. This is taxed as follows:
£37,500 @ 20% =
|
£7,500
|
£80,000 @ 40% =
|
£32,000
|
| |
£39,500
|
Payment of the pension contribution will restore Stephen's personal allowance to the full £12,500. His taxable income after personal allowances of £107,500 is taxed as follows:
£37,500 @ 20% =
|
£7,500
|
£20,000 @ 20% =
|
£4,000
|
£50,000 @ 40% =
|
£20,000
|
| |
£31,500
|
The tax relief on his pension contribution is therefore £4,000 + (£39,500 - £31,500) = £12,000 which equates to an effective rate of 60%.
In the above example, Stephen's net income after tax, pension contribution and National Insurance is as follows:
Income
|
120,000
|
Personal pension contribution
|
(16,000)
|
Income Tax
|
(31,500)
|
NI
|
(6,364)
|
Net
|
66,136
|
If Stephen entered into a salary sacrifice arrangement with his employer then a higher pension contribution could be made by his employer due to the NI saving as follows. For further information on salary sacrifice see the article Salary Sacrifice.
Income
|
99,310
|
Personal pension contribution
|
Nil
|
Income Tax
|
(27,224)
|
NI
|
(5,950)
|
Net
|
66,136
|
Stephen's reduction in salary from £120,000 to £99,310 means an employer pension contribution of £20,690 could be made. If the employer also contributed the 13.8% employer NIC saving then an additional £2,855 could be paid giving a potential employer contribution of £23,545.
