£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.
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