Hi °C | Lo °C Over the past few years many people formed the view that 'my property portfolio is my pension'. Indeed for many people property gains have way out-stripped any rises in regular pension funds.
As the property and mortgage market becomes a bit more jittery I thought I should once again revisit the subject of pensions and tax relief.
The tax relief can make a poor performing pension more lucrative to you than a better performing property investment due to the tax relief topping up the pension contributions at the outset.
Another point to bear in mind is that just because you decide to invest in a pension does not mean turning your back on property.
You may have enough in your pension so that you can use it to purchase commercial property – anywhere in the UK. Or your pension savings could be invested in funds which are themselves property-based.
Residential property is more tricky since Gordon Brown said he would allow pension purchases of residential property and then spectacularly changed his mind.
What makes more mainstream pension investments attractive is the large amount which can be invested nowadays and the tax relief which can be obtained.
Both figures rose dramatically in April 2006 and anyone thinking of pension contributions needs to know the new rules. These include:
› no limit on the amount you can contribute to a pension;
› the amount on which you can get tax relief is limited to your UK earnings for the year;
› if your pension fund at retirement exceeds £1.6m there could be a tax charge then;
› if you have low, or no, earnings you can still contribute £3,600 per year and get tax relief;
› retirement generally will be 55 or later;
› pensions can be taken out for children and tax relief on £3,600 obtained.
While there is no limit on how much you can put into a pension, most people would limit their contributions so that they get tax relief on the lot.
If they choose to do that then they are restricting themselves to their UK earnings. That means their employment earnings plus the value of benefits in kind, like company cars. Self-employed profits also count as earnings for tax relief purposes.
Higher rate tax relief will also be due to the extent that (without the pension contribution) you would have paid 40% tax.
So how do the numbers work?
Example A – employee on £60,000 per year.
This employee is paying higher rate tax on around £20,000 of her income. Suppose she decides to make a pension contribution of £20,000 gross to get the best tax relief:
Net contribution 78% x £20,000 = £15,600;
Tax relief added to pension fund = £4,400;
Gross pension contribution = £20,000.
When she completes her tax relief the balance of the 40% tax relief will produce a tax refund. With 22% tax relief already obtained this balance is 18% of the gross, ie £3,600.
The employee wrote out a cheque for £15,600 and has not got £3,600 back from the Revenue. Thus her pension investment sits at £20,000 but has only cost her £12,000. That's a good start for any investment.
Example B – self-employed person earning £30,000 per year.
This man does not earn enough to pay 40% tax. Let's assume his income, a recent bequest from granny and his savings allow him to invest £20,000 gross in his pension:
Net contribution 78% x £20,000 = £15,600;
Tax relief added to pension fund = £4,400;
Gross pension contribution = £20,000.
As in the first example, this guy will write a cheque for £15,600 yet his pension fund will be topped up to £20,000. Thus he has received his 22% tax relief. No more relief is due since he only pays tax at 22%. He will still enter the pension contribution on his tax return, but it will not change his tax bills.
Pensions can be arranged on the internet, although you will have to post off your identification papers and so on. Alternatively speak to an independent financial adviser.
Adrian Huston, a former tax inspector, is now a partner in Belfast tax and accountancy firm Huston & Co LLP (www.hustontax.com; tel: 028 9080 6080).
