Smarter accounting

Protect your cash from the tax increase

24 March 2022, Advocates, Artists, Barristers, Companies, Creative Industries, Employer, General, Musicians, Sole Traders

The Spring Statement 2022 confirmed increases to tax and National Insurance from 6th April 2022.  The (mild) good news is that the threshold for paying National Insurance increases to £12,570 from July 2022.  There are still opportunities for most taxpayers to take advantage of a tax break in the form of pension contributions.
Protect your cash and set up a pension

What is so good about pensions?

Pension contributions are a really good device to protect your cash from the taxman.  It has been expected for a long time that the tax regime might be amended to reduce the tax benefits of pension savings, but the Spring Statement 2022 kept the current system in place.  A previous chancellor Philip Hammond described pensions as “eye-wateringly expensive“, but the alternative is probably even more expensive for the public purse as private pensions reduce the costs of retirement for the state.

Any personal contributions you make to your pension scheme have an automatic tax credit at the basic rate of tax  – 20%.  This means for every £80 you pay into your scheme as an individual the amount in the scheme increases by £100.

If you run your business through a limited company, you can make employer’s pension contributions.  These payments do not attract National Insurance so they are cheaper for the company than salary payments.  The company can offset these payments against profits so will save tax at 19% of the contribution.

How to protect your cash with just £1

If you don’t already have a pension scheme set up, set up a scheme before 5th April and even if you just add £1 you can start to protect your cash from the taxman (and yourself).

The starting position for taxpayers is an annual allowance of £40,000 for the tax year.  As long as you have an active scheme, any unused allowance can be carried forward for up to three years.

The rules can be complicated for working out your pension allowance so seek advice if you earn more than £200,000 or have accessed your pension already.

What are the drawbacks of pension savings?

From a tax point of view pension savings are probably the best thing you can do to protect your cash from HMRC.  You receive tax credits when contributions are made and you don’t pay tax on the capital gains.

The only real drawback is really the entire purpose of pensions.  You won’t be able to access any funds until you reach retirement age.  For some people this might be the biggest benefit as it protects your cash from yourself.  We will all have to pay for our own retirement.  State pensions are likely to dwindle in value so it makes sense to lock away cash now so you can afford to stop working eventually.

The rules are changing to increase the age when you can start drawing your pension.  See my article on the pension age increase.

Are pension savings completely tax free?

Unfortunately not!

There’s no limit on the amount that an individual can contribute to a registered pension scheme.  If you’re a UK resident aged under 75 you may receive tax relief on your contributions to registered pension schemes.

Tax relief is limited to relief on contributions up to the higher of:

  • 100% of your UK taxable earnings
  • £3,600

You don’t pay any tax if you stay within your annual allowance.  Even non earners start with an allowance of £3,600 so there is something for everyone.

When you start to draw your pension, you will pay tax on the income you receive.  You used to have to buy an annuity, but current rules allow you to draw down directly from your pension fund, which allows tax planning to pay tax at the basic rate.  The rules on pension draw down are complex, so make sure you get professional advice before you consider this.

What else can I do to avoid the tax hike in April 2022?

  • If you run your business through a limited company, consider paying dividends before 6th April 2022 to pay tax at the current lower rates.
  • If you are a sole trader and have a choice between cash and accruals accounting, consider accruals accounting so you can increase your income with Work in Progress and shift more earnings into the current year with the lower rates of National Insurance.

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