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# Contributing factor

The problem: The client has a salary of more than £100,000 and is keen to examine how his pension contributions would affect the reduction in his income tax personal allowance.

The solution
Stephen, who is aged 47, has a net income of £112,500. If he pays a pension contribution of £12,500 gross, then his adjusted net income for personal allowance purposes will be £100,000.
Without a pension contribution Stephen’s personal allowance is £1,855 and taxable income after personal allowance is therefore £110,645. This is taxed as follows:

£34,370 @ 20% = £6,874
£76,275 @ 40% = £30,510
Total income tax = £37,384

Payment of the pension contribution will restore Stephen’s personal allowance to the full £8,105. His taxable income after personal allowances of £104,395 is taxed as follows:

£34,370 @ 20% = £6,874
£12,500 @ 20% = £2,500
£57,525 @ 40% = £23,010
Total income tax = £32,384

Issues to look out for

• The reduction of personal allowance for income of more than £100,000 a year
• Using salary sacrifice to make the most efficient pension contribution and offset the loss of the personal allowance

The tax relief on his pension contribution is therefore £2,500 + (£37,384 – £32,384) = £7,500, which equates to an effective rate of 60 per cent.
In the above example, Stephen’s net income after tax, pension contribution and national insurance is as follows:

Income £112,500
Personal pension contribution £(10,000)
Income tax £(32,384)
NI £(5,587)
Net £64,529

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.

Income £99,570
Personal pension contribution Nil
Income tax £(29,712)
NI £(5,329)
Net £64,529

Stephen’s reduction in salary from £112,500 to £99,570 means an employer pension contribution of £12,930 could be made.
If the employer also contributed the 13.8 per cent employer NIC saving, then an additional £1,784 could be paid, adding up to a potential employer contribution of £14,714.

Graeme Robb is technical manager at Prudential

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