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 £2,570 and taxable income after personal allowance is therefore £117,430. This is taxed as follows:
£37,700 @ 20% =
|
£7,540
|
£79,730 @ 40% =
|
£31,892
|
|
£39,432
|
Payment of the pension contribution will restore Stephen's personal allowance to the full £12,570. His taxable income after personal allowances of £107,430 is taxed as follows:
£37,700 @ 20% =
|
£7,540
|
£20,000 @ 20% =
|
£4,000
|
£49,730 @ 40% =
|
£19,892
|
|
£31,432
|
The tax relief on his pension contribution is therefore £4,000 + (£39,432 - £31,432) = £12,000 which equates to an effective rate of 60%.
Stephen's net income after tax, pension contribution and National Insurance is as set out below. National Insurance is calculated using the ‘Effective Annual Threshold’ of £11,908 which refers to the Primary Threshold level if the weekly level was applied for a full year. This is based on the Primary Threshold being £9,880 from 6 April 2022 until 5 July 2022, and then £12,570 from 6 July 2022 until 5 April 2023.
Income
|
120,000
|
Personal pension contribution
|
(16,000)
|
Income Tax
|
(31,432)
|
NI
|
(7,349)
|
Net
|
65,219
|
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
|
98,855
|
Personal pension contribution
|
Nil
|
Income Tax
|
(26,974)
|
NI
|
(6,662)
|
Net
|
65,219
|
Stephen's reduction in salary from £120,000 to £98,855 means an employer pension contribution of £21,145 could be made. If the employer also contributed the 15.05% employer NIC saving then an additional £3,183 could be paid giving a potential employer contribution of £24,328.