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Time to review pension contributions

The 2019/20 tax year commences on 6 April and it brings with it a number of changes.  Whilst the Scottish income tax rates that apply to non-savings and non-dividend income are unchanged from the current tax year 2018/19, the personal allowance before tax is paid is increasing from £11,850 to £12,500 meaning that most taxpayers, other than those earning over £100,000 per annum, will pay £140 per annum less income tax than they currently do.

Auto-enrolment pension rates are set to increase on 6 April and it is likely that many of the 10 million employees who have auto-enrolled will see their personal pension contributions increased from 3% of their salary to 5%.  This means employees earning over £15,000 per annum may see no increase in their take home pay as the £140 saving given by the increase in personal allowance will be taken away by the additional cost of the pension contribution.

The comparison for Scottish taxpayers going forward to the rest of the UK is not favourable.  Scots earning £26,993 per annum will be no better or worse off than the rest of the UK, with those earning below that being around £20 per annum better off.  Those earning more than that amount will be worse off.  Someone in Scotland earning £30,000 in 2019/20 will pay £30 more in tax than they would in the rest of the UK; someone earning £60,000 will pay £1,644 more and a £175,000 earner will pay £2,919 more.  The higher tax bills arise as a result of the higher rate tax band not increasing in line with the rest of the UK and higher rates of tax being applied in Scotland for higher earnings.

Taxpayers who pay tax at the higher rate should think about paying additional pension contributions as the tax relief is generous and may not continue for much longer.  For those earning in excess of £43,431 in 2018/19 pension contributions attract tax relief at 41%, meaning that for every £1 paid net of tax, £1.69 is invested.

There are two groups of taxpayers where making pension contributions are very cost effective.  Pension contributions have the effect of reducing income for child benefit clawback purposes.  For those who have children and earn over £50,000 then child benefit is scaled back.  For those earning over £60,000 child benefit is withdrawn altogether.  Therefore, those parents who earn over £50,000 should consider paying a lump sum into their pension prior to 5 April, not only to make a tax saving at 41%, but also to save their child benefit.

The second group who particularly benefit are those taxpayers who have income in excess of £100,000.  For income in excess of £100,000, the personal allowance begins to withdraw at the rate of £1 for every £2 of income above £100,000.  The impact is a marginal tax rate of 60%.  

Whilst saving tax by making pension contributions is valuable, the act of saving for a pension is, in itself, important.  Government resources are stretched and prudent taxpayers should attempt to be self-sufficient in retirement to secure their own future.  I find that clients generally underestimate how much they need to save and also what the effect of delaying contributions has on their eventual pension pot.  Someone who is currently aged 35 wishing to retire at age 65 will have to pay 34% higher pension contributions if he or she delays making monthly contributions by just 5 years assuming a growth rate of 5% per annum.  Delaying by 10 years means that the same person would need to pay 69% more per month if they started contributing at age 45 to get the same pension.  With the tax year end approaching, it is a good time for taxpayers to review their affairs and maximise the relief available.