£50K for the price of £30k
Does this title sound strange? Keep reading...
Today I will make tax a little more interesting by telling you a story.
One man had his eye on a very expensive pot which was worth £50,000. He believed the pot was a fair retirement investment and looked everywhere but could not find any cheaper price for that pot. He then decided to buy it for £50,000. He went to the merchant and asked him to pack the pot. Upon receiving the package, he handed the merchant £50,000. The merchant than handed him back £20,000. The buyer asked the merchant incredulously, as to why is he giving him a pot for £30k when it is worth £50k? The merchant replied, a small gift for a wise investment.
Did I make you wonder how could one buy something for a lot less than its worth? If yes, than please read on…
It is always wise to save up for a rainy day. It is even wiser to save up and save even more by getting tax relief. You can choose to save using your savings account and earn a meagre interest rate or pay into an approved pension scheme and attract substantial tax relief.
I believe keeping this simple would help you understand the tax benefits of paying into an approved pension scheme.
In simple terms, every £80 you pay into your pension, you end up with £100 in your pension pot.
Imagine if banks started doing that with your savings account? SIGH.
Examples are always the best way to explain so here goes:
If you are a basic rate tax payer and invest £8000 in to your pension. The government will add £2000 and make it a total contribution of £10,000.
If you are a higher rate tax payer i.e. pay tax at 40% and invest £8000 in to your pension. The government will add £2000 and make it a total contribution of £10,000. You can also claim a tax relief of another £2000. Therefore a £10,000 pension pot would effectively cost you £6000.
If you are an additional rate tax payer i.e. pay tax at 45% and invest £8000 in to your pension. The government will add £2000 and make it a total contribution of £10,000. You can also claim a tax relief of another £2500. Therefore a £10,000 pension pot would effectively cost you £5500.
The annual contribution limit for 2014/15 is £40,000. The annual amount is reduced to £40,000 from £50,000 in 2013/14. There are carried forward options available that I will not discuss here to keep the simplicity.
In summary, In 2014/15, if you are a higher rate tax payer and contribute £40,000 in to your pension the government will add another £10,000 and you will end up with a pension pot of £50,000. You will also claim another £10,000 in tax relief that could be claimed through your self-assessment and the same pension pot of £50,000 will cost you £30,000.
Was the merchant right about small gift for a wise investment?
I will let you decide.
Please note: This doesn’t not constitute as tax advice. Professional advice must be sought before any tax planning. The tax planning may differ based on your individual circumstances.
Accountant Directory is not responsible for the articles published by members. The views expressed are those of the member who wrote the article.
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