1. Personal allowance for high earners
Currently, the personal allowance is reduced by £1 for every £2 of taxable income over £100,000. The current individual allowance of £8,105 would be completely eroded once taxable income reaches £116,210.
By making a pension contribution, an individual can reduce their taxable income and reclaim their allowance. This is particularly valuable for individuals with a taxable income of between £100,000 and £116,210.
As well as receiving 40% tax relief on their pension contribution, reclaiming their personal allowance will give them an effective tax relief rate of up to 60%. If they earn over £116,210, they can still reclaim some personal allowance if their taxable income after the contribution falls below £116,210.
2. Erosion of child benefit
From 7 January 2013, if a parent earns in excess of £50,000, child benefit reduces and is completely eroded once earnings hit £60,000.
A pension contribution can help reduce earnings and allow child benefit to be reclaimed as an added bonus.
3. Maximising tax relief on contributions but minimising tax on pension income
Through efficient planning, some clients may be able to receive tax relief at a higher rate than the income tax rate they would pay when it came to taking their retirement income.
Assuming a client retires with effectively 60%-70% of their working income, they may have been receiving tax relief on their pension contributions at a rate of 40% or 50% but pay a lower rate of income tax in retirement.
Many advisers may recommend the use of income drawdown as an effective way of controlling pension income in retirement.
4. Paying in excess of the £50,000 annual allowance but avoiding tax charges
In certain circumstances clients can pay in excess of the annual allowance without penal tax charges applying.
A client can carry forward three years’ worth of unused annual allowance, meaning, subject to earnings, they could contribute up to £200,000 gross in a tax year and claim valuable tax relief at their marginal rate of income tax.
Take a look at the following example:
As the annual allowance for these tax years is £50,000, there is £60,000 unused annual allowance available.
When added to the current year’s annual allowance, a contribution of up to £110,000 gross can be made in the 2012/13 tax year without incurring any tax charges.