Irene needed the money and was going ahead with the encashment and asked her adviser for an idea of the tax liability. If the bond were to be fully encashed, the client would lose her personal allowance (as you use the full gain to assess that), increasing her tax liabilities to £29,262. That is an increase of £22,576, which is not too bad on a £250,000 bond gain, and comes in at 9 per cent of the bond gain.
Irene’s 'slice' was £6,757, and only £2,487 of it was in the higher-rate tax band. This resulted in top-slicing relief of £38,898. Now that Irene had no relevant earnings, knowing that you could pay in £3,600 without needing to have any her adviser suggested just that.
This contribution raised Irene’s higher-rate threshold by £3,600 and meant the slice that was previously in the higher-rate tax band fell into the basic-rate band. Increasing her top-slicing relief by £18,222 to £57,120.
This meant the overall tax liability was reduced to £10,140 from £29,262, so a saving of £19,122 on the potential payment to HM Revenue & Customs.
When you add in the £720 relief at source in the pension from HMRC it is an overall tax saving of £19,842 from a £3,600 gross pension contribution. As a percentage of tax relief on the pension contribution, that is (£19,842/£3,600) x 100 = 551%.
Many people can benefit from this method of saving tax on bond gains, but before 2001 it would have been no use to Irene pre 2001 as she would not have had the relevant earnings to support her pension contribution that made all the difference to her tax bill.
So while there has been a multitude of changes to pensions in the 21st century, the basic fundamental mechanics of tax relief have remained untouched, other than the innovation of allowing pension funding without the earnings to support it.
Many people should be thankful that this change has made it to its 21st birthday and hope it sees many more.
So, it should be a happy birthday to “…or £3,600 or more”, especially from those who have, can have and in future will have a financial benefit because of it.
Les Cameron is head of technical at M&G Wealth
