How to avoid 40% tax and boost your pension

Almost 4m people face paying higher-rate tax from April, but some higher earners can avoid the 40 per cent rate altogether by boosting their pension contributions.

The Institute of Fiscal Studies said this week that about 750,000 basic-rate taxpayers are set to pay 40 per cent tax for the first time in 2011/12 as a result of the reduction in the higher-rate threshold from 43,875 to 42,475 that was announced in last summer’s Budget.

This will take the total number of higher-rate taxpayers close to the peak levels of just before the recession, according to Grant Thornton, the accountants. It also means that existing higher-rate taxpayers will pay 40 per cent on more of their earnings.

However, taxpayers who contribute more to their pensions can reduce these bills and even avoid paying any tax at the 40 per cent rate.

“Higher-rate relief is a very attractive upfront tax break for wealthier pension savers – especially as they may pay only up to 20 per cent on their pension in retirement,” says Laith Khalaf, pensions analyst at Hargreaves Lansdown, the financial adviser.

For a higher-rate taxpayer, each 1,000 contributed to a personal pension offers a 250 reduction in their tax bill on top of the same amount of basic-rate relief.

The additional higher-rate relief generally needs to be reclaimed through a tax return, while the basic-rate relief is added automatically to the plan value – boosting a 1,000 contribution to 1,250.

CandidMoney.com, an advisory website, gives the example of a higher-rate taxpayer earning 65,000 with 1,000 of taxable savings interest – whose total income tax liability could be as much as 16,330 this year.

However, by paying 14,800 into a personal pension, as well as contributing to an occupational pension and donating tax-efficiently to charity, the person could reduce the higher-rate tax by 4,500 and boost his or her pension fund by a total of 28,250, including 4,350 of basic-rate relief. The tax savings and relief would total 8,850, the amount of tax otherwise payable at 40 per cent.

Justin Modray of CandidMoney.com says: “This is the nirvana situation, but even getting some way there can yield sizeable benefits.”

Many investors may not have the spare cash to top up their pensions. But if they have non-pension investments they could get the tax relief by switching these into a self-invested personal pension (Sipp).

To reduce tax bills for the current year, contributions must be made by April 5, although cash need not be invested until a later date.

For those earning just over 100,000, paying into a pension can also allow personal allowances to be reclaimed – effectively giving them up to 60 per cent tax relief on contributions.

Although there are tax relief restrictions for some high earners, this affects only those with incomes of more than 130,000 in the current tax year, while from April the contribution allowance for all pension savers is capped at 50,000.

People wanting to calculate how much to contribute to a personal pension to wipe out a higher-rate tax liability need to work out how much income they have above the 40 per cent threshold, then multiply this figure by 0.8. They also need to reduce their higher-rate earnings figure to take account of sums already getting tax relief – contributions to occupational pensions, for example.

In simple terms, investors on an income of 53,875 – 10,000 more than the current 43,875 threshold – could get 40 per cent tax relief on up to 8,000 of contributions, depending on the other reliefs they qualify for. If they contribute more, they simply receive basic-rate relief on the excess.

Making donations under Gift Aid yields the same additional relief as a pension to a 40 per cent taxpayer, while the basic-rate relief goes to the charity.

What next for pensions in 2011?

Sure, 2011 can't possibly be as action-packed as 2010 for pensions, but plenty of loose ends need tying.

And some big reforms await a spot in the limelight.

Most notably, a 'universal' state pension for all Britons is on the cards.

This could provide a single £140-a-week payment for all retired Britons. It would help beat off the confusion caused by means-tested pension credits.

The Treasury has been very quiet since details of the plans were leaked in Autumn 2010, but something momentous is most likely brewing in Whitehall.

Elsewhere, a few of pensions minister Steve Webb's fiddly reforms will need wrapping up.

Public pensions are under the microscope after being accused of being 'unaffordable' by the Government.

A final verdict from the Hutton Report is due before the Budget next March. This will lay out a programme for reform and is likely to be adopted 'in full', the Government has said.

For a taster of what to expect, read our Q&A on what next for public pensions. The main changes will mostly likely be higher contribution levels for employees, a move to calculations based on average pay over an entire career (rather than final salary) and an increased retirement age to match the private sector.

A byproduct to watch out for is union action. Angered firemen, teachers and nurses across the country could strike if their entitlements are downgraded dramatically.

Elsewhere, final salary schemes' yearly tumble towards grizzly death will continue. New EU rules announced in December added another nail to the coffin (how many 'final' nails do we need?). Hundreds of employers may be forced to abandon their schemes if Brussels regulations push up the cost of administering funds by an expected 90%.

Many will be hoping that the Government then decides to stop tinkering with its reforms and let us get on with the very urgent job of saving for retirement. Expect more reports of how little most Britons are stashing away.

Those approaching retirement – the so-called 'babyboomer' generation – could be in for a tough year. That's because annuity rates will come under new pressures.

Although fresh rules will allow some people to opt out, annuities are the products that will convert pension pots into retirement incomes for most people.

At the moment a £100,000 pension pot buys a pension of around £6,000 a year. Rates have drifted steadily downwards over the last 20 years as yields on Government bonds, which back up annuities, have fallen.

In late 2010, bond yields rose. So did annuity rates. But in 2011 an EU-wide ruling will require insurers – providers of annuities – to hold more capital in reserve. Called Solvency II, this could act as a downward pressure on rates.

Follow Billy Burrows' monthly annuity update to find out the prospects for your retirement income.

Watch out for new rules that allow early access to pension pots. A consultation has been launched already. It is something Steve Webb holds close to his heart - he reckons it'll boost pension saving and help stave of a crisis. a

Saga director-general and pensions expert Ros Altmann agrees. She says: 'The pensions 'locked box' is so old-fashioned. It's great for the pensions industry of course, but puts many basic rate taxpayers off the whole idea, so they miss out on their employer's contribution.'

Half of middle-aged will sell home for care

Some 44% of couples aged 34-54 fear parting with their biggest asset is inevitable should one of them need domiciliary or residential care, a YouGov poll of 4,500 people found.

Additionally, 38% of those aged over 55 admit they won't be able to meet the cost of care without selling up, law firm Dickinson Dees says.

Last year, 20,000 pensioners were forced to sell their homes to fund care fees, undermining a lifetime of hard work, saving and paying off mortgage debt.

If Dickinson Dees' figures are representative of the general population, some 2m middle-aged Britons are in a position where they'd have to sell up to pay for long-term healthcare.

The report comes just weeks after official statistics showed that 10m living Britons – 17% of the UK population – is expected to live past 100.

Each year 130,000 older people start requiring long-term care. This could be set to soar as a generation of baby-boomers born after the Second World War hit retirement – and stay alive for longer.

Full-time residential care costs from £30,000 a year, depending on location, the quality of home and the medical care needed.

Most people must fund this cost from their own pockets. According to Deborah Jude, a partner at Dickinson Dees, many forget that UK law requires anyone whose total assets – including their property and any investments – fall above £23,250 has to pay for their own care.

With around 18m owner-occupied houses in the UK, selling up is one of the most common ways used to free up enough cash to pay the sky-high costs. That wealth then drains away at an alarming rate.

›› Reader service: How to protect your assets from care home costs

Jude says that the sudden loss of a lifetime's worth of savings can be quite a shock to family members.

'Care is not something we like to talk about,', she says. 'Families think it's too morbid as nobody wants to end up in a care home – it's a taboo.'

'But it can be really upsetting to find out an entire inheritance or family home has to be spent on care. There are a few ways to shield some of this wealth, using a wills and gifts, but plans need to be drawn up when people reach retirement, not after they've drifted into infirmity.'

Some nifty tricks to beat care costs include gifting a home to their grown-up children or creating a trust for their benefit, Jude says. Also, leaving assets individually – not in a joint will – to children rather their spouse can help couples protect more of their wealth.

Care is means-tested, so someone with assets between £14,250 and £23,250 receives help on a sliding scale. The poorest get basic care provided by the State. In Scotland the limits are £22,750 and £14,000. In Wales there is no sliding scale - the State pays for everything once assets are less than £22,000.

Read more: Your guide to meeting the soaring cost of care

New state pension age: when will you retire?

For many years the age at which you can claim your state Pension benefits has been 65 for men and 60 for women.

But the previous Labour government set out plans, based on recommendations from Lord Turner, to steadily increase the state Pension age to 68 for both men and women over the next four decades.

In May, the new coalition Government initially signalled its intent to speed up the process, bringing forward the first rise to 66 for men from 2026 to 2016.

In the end, the Comprehensive Spending Review in October 2010 settled on a less radical option, confirming the rise to 66 for both men and women would come by 2020.

However, the Government said it will have to rise even higher in following years. This could see many Britons working today wait until age 68 or even 70 before they get their state Pension.

- Latest: State Pension age will rise to 66 by 2020

For women, the new rules mean much more dramatic rises than feared. It had been expected that the women's state Pension age would rise to 65 by 2020. It will now move to 65 by 2018 and then be hiked to 66 (same as men) by 2020.

The previous Labour government's policy had been to raise the state Pension age to 66 by 2026 and then incrementally to 68 by 2046. Retirement was due to equalise for men and women at 65 by 2020, rise to 66 between 2024 and 2026, 67 between 2034 and 2036, and 68 between 2044 and 2046.

›› When will I retire, then?

All men and women under 56 will have to wait at least until 66 before they can retire.

Those born between April 1950 and April 1954 will have their own specific retirement dates that will gradually increase (see below).

After that, we must rely on Labour's existing plans until the Government makes its next move. See our rough guide to what it means for you below:

MEN - a rough guide

• Under 32s................................. can get state Pension at 68*

• Aged between 32 and 41....................... can get state Pension at 67*

• Aged between 42 and 56.........................can get state Pension at 66

• Aged between 56 and 57.......can get state Pension at 65 + (see below)

• Older than 57......................can get state Pension at 65

WOMEN - a (very) rough guide

• Under 32s..................................can get state Pension at 68*

• Aged between 32 and 41.......................can get state Pension at 67*

• Aged between 42 and 57....................can get state Pension at 66

• Aged between 56 and 60.......can get state Pension at 60-65 (see below)

• Older than 60..............can get state Pension at 60

*Warning! These changes are under review and will be altered by the coalition Government. Expect further announcements 'in due course', they say.

So what about if I was born between 1950 and and 1954?

Because the state Pension age will be increasing gradually between 2010 and 2020, many men and women will retire at different ages.

The last women to retire at 60 has already done so. Between now and 2016 the retirement age for women will rise to around 63. Then between 2016 and 2018 it will rise to 65.

Then, between 2018 and 2020, the retirement age for both men and women will rise to 66.

After an agonising delay (during which This is Money made its own rough estimate while waiting for the Government to act), the Department for work and Pensions has finally released the exact new state Pension ages.

Note that these proposed changes to the timetable are not yet law and still require the approval of Parliament (as of November 2010).

Read the full report: Official state Pension ages revealed at last

Existing timetable for women:

New changes for women only:

New changes for women AND men

Soon, you should be able to find out exactly when you will be able to claim your State Pension by going to the Pension Service website calculator. [Yet to be updated following the Spending Review changes].

The coalition Government is consulting on making these further rises. Read more about the proposals below.

• GUIDE: The State Pension

Moving retirement above 65

The new plan The Pension age for both men and women will rise to 66 by 2020 - much sooner than the 2026 target set by Labour. Rises to 68 are expected to be announced soon, with age 70 on the horizon. The previous reforms would have increased Pension ages gradually, by two years every decade.

There are suggestions that the state Pension age could be linked so that it rises with life expectancy, although this will not be 'crude' relationship, the Government says.

Experts reckon that a target of 70 could be in the Government's mind. Although any changes to that age will be implemented over a longer time period.

Your choices at state Pension age

When you reach the milestone of the state Pension age, you essentially have three choices.

• Cease your working life and get your state Pension

• Continue to work and receive your state Pension as well

• Carry on working and hold off claiming your state Pension

In regards to the final option, if you postpone claiming your state Pension, you may get extra state Pension when you do finally decide to claim it. And you can put off taking it for as long as you like.

Editor's Blog: Will the retirement age be raised to 70?

When you do eventually decide to take your state Pension, you can choose to receive either extra state Pension for the rest of your life, or receive a one-off, taxable lump-sum payment, equivalent to the benefits you put off claiming plus interest - as well as your regular weekly state Pension.

In addition, you can also choose to stop claiming it after having claimed it for a period. And remember, if you carry on working after state Pension age, you don't have to carry on paying National Insurance contributions (Nics).

• For further information on the state Pension and changes to the Pension rules visit Directgov.

›› This is Money has teamed up with our sister title MailOnline to create a new wealth check tool - powered by Pensiontracker - that will calculate how much you need to save for retirement: ›› 2 minute Pension healthcheck calculator

Updated November 2010, Dan Hyde, This is Money

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Yet another battering for our pensions

The government and companies have been trying to scale back their liabilities for pensions, on the basis they have become unmanageable.

The effect is to transfer the responsibility and the risks of retirement provision on to individuals.

There is probably no alternative, but the shift must be accompanied by an awareness that many individuals are not well-placed to cope, because they lack the money, the time or the knowledge to take care of themselves.

The seismic transition from a paternalistic Pension system, where the state and the employer provide, to one where people are on their own must be fair, proportionate and realistic, or the whole enterprise will fall apart.

The coalition is plugging the message that we will all have to work longer and save more to enjoy a decent standard of living in old age.

These are big demands to place on people already in their 50s, and the situation is being made worse because the goalposts keep moving.

The most insidious example of this is the aggressive rise in women's state Pension age proposed in the autumn, when Chancellor George Osborne reneged on a coalition pledge not to bring in any further changes until 2020.

My mailbox has been filling up with angry letters from middle-aged women whose planning has been thrown into disarray. Women's state Pension age of 60 was already scheduled to start increasing gradually from April 2010 to 65 by April 2020, and then to go up again to 66 between 2024 and 2026.

This timetable, though, has been dramatically accelerated so it will go up by six years between 2010 and 2020, compared with an increase for men of just one year.

It emerged this week that the biggest losers are more than 30,000 women born in 1954 who are currently due their state Pension at the age of 64, but who under the new plans will have to wait a full two years longer.

Pensions equality is a perfectly reasonable principle, but the speed of this shift will hurt some women disproportionately.

It also ignores the reality that this age group have, for much of their careers, not benefited from workplace equality and so have not had the opportunity to build up adequate private savings.

Many of those who wrote to me point out they are the 'sandwich' generation, caring for grandchildren and elderly parents with little chance of earning enough to make up for their loss of state Pension now.

The BBC may have changed its stance on middle aged female employees after the furore over Miriam O'Reilly, but ageism is alive and well in many firms.

Equitable Life victims feel similarly cheated by the government.

They were told earlier this week that more than half of them will receive compensation of £250 or less. Before the election, the coalition promised to deliver speedy redress to policyholders, who had been subjected to shameful and cynical delays under Gordon Brown's Treasury, but this package falls far short of the expectations raised.

Then there is the worrying situation at Northern Foods. Business secretary Vince Cable, in opposition, was vocal on the subject of takeovers that could damage employees' interests. Yet the board of Northern has given its backing to a £342m takeover bid by poultry baron Ranjit Singh Boparan, despite his refusal to disclose in public any information about his plans to repair the £142m deficit in the Pension fund.

Since Boparan would be taking on more than half a billion pounds of debt in a deal, it is quite legitimate for the Pension scheme's 20,000 members - and the public at large - to want some information. But under current rules, none is required. Surely it's time Pension funds were part of the takeover debate.

Company Pension fund members do have some protection, but Dr Ros Altmann, the director general of Saga, has highlighted a worrying hole in the lifeboat.

One small fund, the George and Harding scheme, has been turned away by the Pension Protection Fund, which helps people who lose their retirement savings when their employer goes bust.

They are being denied aid, because, in a shameful bit of Clinton-esque verbal wriggling, the PPF has classed the company responsible for the scheme as a 'principal', not a 'statutory' employer. So far the government has done nothing to plug the loophole in the law.

What unites these various strands is the way in which companies, officials and ministers are prepared to ride roughshod over individual pensioners.

Everyone knows the public purse is threadbare, but unless we address the pensions issue, the costs of caring for an ageing population will put the nation's finances on an unsustainable path.

So it is vital that individuals do take on the responsibility of saving for retirement. But they are not likely to do that if their trust in pensions is repeatedly and cynically betrayed.

Can I put my pay-off into my pension?

I am being made redundant and my employer is offering an
ex-gratia payment, part of which I can take as a contribution to my money purchase pension scheme to avoid tax. The payment will take my total earnings above 150,000. Are such redundancy payments – whether coming as income or employer pension contributions – subject to limits on pension savings tax relief?

Laith Khalaf, pensions analyst at financial adviser Hargreaves Lansdown, says restrictions may apply for payments received in this tax year, but things are changing for the better in April.

You might be caught by the current pension contribution limit of up to 30,000 if your “relevant income” for the year exceeds 130,000. This figure includes employment earnings and the taxable element of your redundancy payment (typically, the first 30,000 of a pay-off is tax-free). However, in calculating the income figure, you may deduct personal pension contributions of up to 20,000.

So, for example, if your total earnings (including taxable redundancy pay) are 145,000 but you make a 20,000 pension contribution, HMRC deems your relevant income to be 125,000 and you would not be caught by the new restrictions. In this case, the taxable part of your redundancy payment can be restructured as an employer pension contribution, subject to a limit of 255,000 including any other contributions made in this tax year.

However, if you are caught by the restrictions, the contribution that your employer can make without triggering a tax charge for you is limited. The limit depends on your circumstances and could range from zero to 30,000. For many, the figure will be 20,000 minus their other pension contributions in that year. If total contributions exceed your limit, you will be subject to a tax charge of up to
30 per cent on the excess.

These rules are being scrapped from April and replaced with a flat 50,000 annual pension contribution allowance. This could give you greater scope to use a pension to protect your redundancy payment from tax – assuming you can delay matters until the new tax year. Your employer would then be able to pay up to 50,000 into a pension tax-free, irrespective of how much you earn.

You may also be able to carry forward unused pension allowances from the previous three tax years.

Rising rates and the impact on reverse mortgage proceeds

Rising rates and the impact on reverse mortgage proceeds

Reverse mortgage Daily, January 17th, 2010

Sounding like some alien character in a science fiction story, LIBOR is actually a critical financial factor in determining how much money a senior can receive in a reverse mortgage transaction, especially when borrowers may or may not qualify depending on how the index moves.

LIBOR, an acronym for London Interbank Offered Rate, is a “daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market),” according to Wikipedia.

It’s good news for reverse mortgagors when the 10-year LIBOR index drops – used to calculate the expected rate – but not so good when it rises, driving down principal limit factors – and the aforementioned proceeds. Cliff Auerswald, All Reverse mortgage Company, is concerned about seeing the “swap rate” affecting the LIBOR go up “pretty consistently over the last two months,” he says, driving down significantly the amount of money reverse mortgage recipients could obtain.

Auerswald cites one example where a client would have qualified for $286,194 in proceeds on a property valued at $455,000, but waited just long enough to sustain a loss when the LIBOR rose. As a result, the client could only qualify for $243,000. “I think it’s going to affect the viability of the [reverse mortgage] program for many borrowers,” he worries, acknowledging that this rate rise “has happened before – a couple of years ago.”

He notes that the new HECM Saver product, which has a separate and much lower, initial mortgage insurance premium (MIP) option, “uses both the same initial and expected LIBOR rates as the Standard.” One big deterrence, though, is that since the Saver is new to secondary markets, it has been priced at about a .25 percent to .50 percent higher margin, which will produce even lower principal limit factors.

Read more of this article.

About Reverse Mortgages:  Reverse Mortgages fluctuate with interest rates in all sorts of ways, and while rates have been at or near historic lows for some time, they will soon begin to change once again.  As such, it might be a good idea to consider the program now, while rates are still low.