Size Matters
The amount that stands to be gained will depend on the maximum permissible pension contribution, which is based on an individual’s earnings and age. However, the following example illustrates the point.
Take a male aged 47 with earnings of £35,000 for the tax year 2004/05. This means he has used all of his personal allowance and most of his basic rate tax band.
If he has dividend income of £9,000 (grossed up to £10,000 to allow for the 10% dividend tax credit), tax on total income of £45,000 would be £9,407. Tax at 10% would be payable on £1,145 of the grossed-up dividend income, and 32.5% on the balance of £8,855.
However, if the maximum permissible personal pension contribution of £8,750 gross is made, the basic rate tax band is extended by £8,750.
Tax Saving
The £8,750 pension contribution is paid net after deducting basic rate income tax of £1,925 and therefore only costs £6,825. With the extension of the basic rate tax band by the amount of the gross pension contribution (£8,750) to give higher rate tax relief on the contribution, the tax bill is reduced to £7,438. This represents a tax saving of £1,969 (£9,407 less £7,438). Adding the basic rate tax relief (£1,925) on the pension contribution to the tax saved (£1,969) gives £3,894. This means that the effective rate of tax relief on the pension contribution is
£3,894
£8,750 which is 44.5%
An eligible investor with dividend income in the current tax year has until 31 January 2006 (with a carry back election which must be made no later than the date of payment of the contribution) to make a pension contribution to take advantage of this situation. The size of the pension contribution will, of course, depend on individual circumstances.
To discuss your situation, please e-mail or contact us for further information.
Levels and bases of, and reliefs from taxation are subject to change.
