Time may have run out to submit business for the 2009/10 tax year, but it is never too early to get started on tax planning for 2010/11. The loss of the personal allowance for clients with income over £100,000 gives an exciting new opportunity for you to minimise the impact of this on your clients through pension contributions.
This extra tax bill can be avoided by planning now – do not leave it until the end of the tax year.
So what is the opportunity? Individuals with an “adjusted net income” in excess of £100,000 will see their basic personal allowance reduced or removed entirely from April 2010.
There will be a loss of £1 in personal allowance for every £2 of income earned over £100,000. The personal allowance is lost when earnings equal £112,950 (the personal allowance for 2010/2011 is £6,475) – giving an effective 60 per cent tax bill on this band of income. Looked at another way, this is a 20 per cent increase in tax on a band of £12,950.
What can you do to help your clients avoid this extra tax? The trick is to try to keep your client’s adjusted net income below £100,000, so that they continue to be entitled to the full amount of the basic personal allowance.
Adjusted net income can essentially be defined as taxable income reduced by specified deductions, for example, trading losses, gift aid and pension contributions, so by contributing to their pension plan, clients can keep themselves below the £100,000 threshold.
This extra tax bill can be avoided by planning now – don’t leave it until the end of the tax year
Here is an example to show you how it might work in practice. It considers Paula and the tax relief available if she pays a pension contribution in 2010/11. Paula is earning £112,000, and in April 2010 she started a new pension plan with a contribution of £1,000 a month (£12,000 during the tax year).
If Paula has earnings of £112,000, and no other income, in 2010/2011 she will not only be liable to 40 per cent tax on the top £12,000 slice of her salary but will also lose £6,000 of her personal allowance.
This amount of £6,000 will be liable to 40 per cent tax, meaning the overall tax liability on Paula’s top £12,000 slice of salary is effectively £7,200, or 60 per cent.
If Paula makes a personal pension contribution of £12,000 gross, her adjusted net income will be reduced to £100,000. Not only will this reduce her higher rate tax liability but it also means that she will retain her full personal allowance. Paula’s effective tax relief on the £12,000 pension contribution is £7,200 (60 per cent).
There could be even greater benefits in the future. Do not forget that as well as the loss of the personal allowance NIC will increase in 2011/2012 by 1 per cent for employees and employers. Planning now and meeting the cost of the pension via salary exchange will not only be tax efficient today, but could mean even greater savings in the future.
I hope this has inspired you to get planning for the new tax year – I wish you and your clients a happy, prosperous and tax-efficient new (tax) year.
Steve Meredith is senior manager for pensions financial planning at Scottish Widows