Much comment has been generated around the higher taxes that will be paid by many people, due to Alistair Darling’s failure to raise income tax thresholds in line with inflation.
However, despite misgivings in many quarters before the Budget, he avoided any temptation to increase Capital Gains Tax, or to restrict the tax relief available to most individuals in respect of pension contributions.
Aside from restrictions on those earning in excess of £130,000 a year, anyone can achieve income tax relief at their highest marginal rate (up to 40%), by making a pension contribution.
Where this can really be of great benefit is for any member of a final salary pension scheme which offers access to an ‘in-house’ AVC arrangement (otherwise known as ‘Additional Voluntary Contribution), where the scheme rules permit the member to take up to 100% of the AVC ‘pot’ as a tax-free lump sum.
Whilst many final salary schemes have closed in recent times, a large number of employees (particularly those approaching retirement) still enjoy these valuable benefits.
Not all schemes allow the 100% tax-free lump facility, but, for example, the Local Government Pension Scheme (which has over 3 million members) will allow employees to pay up to 50% of their salary (100% in Scotland!) into the AVC arrangement, with the possibility of getting the whole of the AVC fund back (tax-free) at retirement.
Where this really starts to get interesting is when you consider that the AVC contribution benefits from tax relief, as it is deducted from salary before tax is calculated.
This means that, for example, an employee paying £1,000 per month into the AVC scheme, will benefit from a saving in tax of £2,400 over a year (or £4,800, if they are paying higher-rate tax), and will receive the whole of the AVC fund back as a tax-free lump sum (plus any increase in fund value), when they retire.
Perhaps not practical for someone who is a long way from retirement, but could be a very effective way of getting a tax bonus from the Government in the year or two before retirement.
In this example, they would only receive £9,600 per annum, after tax of the income, if taken as salary, but would get the full £12,000 in their AVC pot, if paid as a contribution.
That’s an increase of 25%, and needn’t involve any investment risk! I dare not even quote the benefit to a higher-rate taxpayer, as you may not believe me!
So, if you are one of the lucky ones in a final salary scheme, you could get even luckier, courtesy of that nice Mr Darling! Why not discuss this with your financial adviser?
