Tax Credits and Pensions

[ChasingSquirrels]

It occurred to me today, that if I made a one-off pension contribution before the end of the tax year (Tue 5th Apr) then I would get the following (I have 2 children, am a basic rate tax payer, working 20hrs per week, with a gross income of around £27k pa - so I get WTC & CTC, although the WTC is all withdrawn due to income level and I am into the 39% withdrawal rates for CTC).

Contribution - say £80 net payment, tax relief added by HMRC = £100 in to pension fund.

Reduction in 10/11 income for tax credit purposes = £100, so an extra £39 (39% withdrawal rate) for 10/11 to be paid once my TC renewal is processed - so Jul 11 at the latest.

11/12 tax credits based on 10/11 income with an income disregard of £10k. 11/12 income withdrawal rate is 41%, so that £100 pension contribution also gives me an additional £41 tax credits in 11/12 to be spread over the year.

So - net payment £80
Net increase in tax credits - 10/11 £39 and 11/12 £41 = £80
No overall net cost and £100 payment into my pension plan.

Can anyone pick holes in this?

(am hoping not - because while a £100 one off payment into my pension is neither here nor there, a bigger payment is more significant but has the same overall cost - nothing, or to be totally accurate the interest lost on the amount put in now, as the additional tax credits will come back 4-weekly over the next year.

As I see it, you could do this up to a gross contribution of £10k, so £8k net payment, and if all other things remained equal for 11/12 v 10/11 then you stay within the £10k income disregard. For a margin of error I would error on the side of caution and maybe do a £8k gross contribution.)

Best place to check your theory is probably this Benefits Checker

Dunno if it's any use to you, but the TUC are apparently developing a tax credit calculator, and looking for MNers to be case studies.
See thread: Case Studies needed - Tax Credit

I did a similar thing and recieved an increase in the tax credits for that year. It hadn't occurred to me and it came as a welcome surprise. I can't remember the exact figures but I think my actual pension contribution cost me 2/3rds in the end. So for example, say I paid in £1,000, it actually cost me £660 in real terms.

plus the tax relief paid in by the hmrc on top of that!

I'm not sure on the 10k income disregard though, I thought it was £300

No, you're right. DH got a big redundancy payment last year and I worked out that if we paid it all into his pension (which is what we were planning on doing anyway) we would get a huge amount more in tax credits. I haven't decided whether to do it or not though, I can't decide whether it's morally the right thing to do

the £300 is the amount of unearned income (like interest and dividends) that you don't count as part of your income for TC purposes.

the £10k income disregard is how much your total income can increase by before your TC's change - your TC's are based on prior year income unless your current year income increases by more than £10k (£10k applies from 6 Apr 11 onwards, it is currently £25k).

I can't see any holes in it - other than maybe an unexpected increase in 11/12 income which would take me over the £10k disregard. But I don't plan on changing my job or increasing my hours and can't foresee a significant pay increase. Interest rates could increase, therefore increasing my investment income - hence leaving a leyway on the £10k, but unless they go astronomical it isn't going to make that much difference, and I could always make a contribution towards the end of next tax year to ensure my income doesn't go up that much if necessary.

I couldn't believe it when it dawned on me, I originally thought - 20% tax relief on the contribution and 39% TC on the claw-back, it is the fact that TC's are based on prior year income unless current year income is lower, and the effective "doubling" of the TC increase that makes this a free pension contribution.

And in 11/12 the clawback is 41%, giving 82% back in TC's when you have only paid 80% of the contribution in the first place. Although the income disregard is also falling I think?

Finally - you only want to do it every 2 years, as doing it every year doesn't give you the same "double" benefit.

Yes the moral aspects - I umm'd about that, and then put £3.5k in, being the most I could lay my hands on immediately. I'm hoping to add some more tomorrow.

I don't blame you at all, I just can't decide whether to do it or not. The silly thing is that we want to pay it into his pension and would have done so regardless of tax credits, and to omit it from our renewal form would actually be dishonest! It would mean that the kids would also be entitled to free school meals despite him being on a more than decent salary. Ho-hum, I've got a year to think about it I guess.

have you got a year DS, or do you want to get it in tomorrow to impact on 10/11 TC's and your 11/12 TC's?

DaisySteiner - how do your children qualify for free school meals? My son doesn't even though we receive wftc on an income of £12,500

Ah, you're right, it's a while since I looked into it and forgot it didn't count if you got WTC.

CS - it's a bit complicated, but because of my work-status 2010-11 compared with 2011-12 and 2012-13, it will have more impact if we do it next tax year, plus of course the withdrawal rate increases to 41% and the different elements increase too.

I'm also concerned that that HMRC will not like us doing it, despite it being totally above-board legally and give us grief in terms of examining tax returns etc.

it is mad really isn't it but why not? You need to invest for your retirement and you have to disclose it on the forms. The alternative is not to claim tax credits?! Like I say, I didn't know about it or it hadn't dawned on me that the tax credits would be upped, it was just a nice surprise after i'd completed the renewal. It could all change very soon so I would make the most of it. Sadly, I can't do it anymore for various reasons!

I mean again, not anymore, I only did it once!

I'd do it Daisy, if you wanted to put the money into pensions anyway, and the TC thing is a bonus then I don't see a moral problem with it.

Mind you my morals have been stretched after reading about some of the tax avoidance that goes on in big business and the MPs expenses thing. If you're working within the rules of the scheme then if anyone has an issue with it, they should argue for getting the scheme changed. I'm sure HMRC are aware of the effects of large pensions contributions on TC, there are even pages explaining it on their website.

DH was lucky enough to get a bonus this year and we realised then that the best place for it was his pension, otherwise after tax and reduction in tax credits, his £2k ended up us about £600 :( I spent some time a few weeks ago with a big spreadsheet working out the effect of increasing pensions contributions on our TC. It was very enlightening DH will be making much bigger pension contributions in the coming tax year.

I must admit I'd not considered the double benefit aspect that CS has found. I had realised that increasing our pension contributions will mean dc will qualify for much better student finance (grants rather than just loans) if the rules are the same in 5 years time (unlikely I know!).

There's no moral dimension to it. In fact, I wouldn't be surprised if the government hadn't deliberately factored in that it would make sense for some to make extra pension payments when working out the scheme in the first place. The amount the average person is currently saving towards their retirement is woefully inadequate (dangerously, some would say) so anything that encourages bigger pension contributions is welcome.

Sorry to hijack (but you all seem to be quite clued up!!)

When giving my annual yearly salary to tax credits - do I give my salary before Pension, NI and Tax or after having these deducted.

I have always given my gross pay and not sure if I should have taken anything off before informing tax credits of this amount.

I a very clueless with regards to TC. I apologise!

On the tax credit form there is a box for Personal pension contributions you paid into a registered scheme. Include Free-Standing Additional Voluntary Contributions and payments to Stakeholder pensions. Enter the gross amount. Don't include contributions you paid through your employer.

HMRC Notes to help with filling out Tax Credit Form