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Get £60,000 for the price of £40,000 – Sounds strange? Keep reading

Today I will make tax a little more interesting by telling you a story.

One man had his eye on a very expensive pot which was worth £40,000. He believed the pot was a fair retirement investment and looked everywhere but could not find any cheaper price for that pot. He then decided to buy it for £40,000. He went to the merchant and asked him to pack the pot. Upon receiving the package, he handed the merchant £40,000. The merchant than handed him back £16,000. The buyer asked the merchant incredulously, as to why is he giving him a pot for £24k when it is worth £40k? The merchant replied, a small gift for a wise investment.

Did I make you wonder how could one buy something for a lot less than its worth? If yes, than please read on….

It is always wise to save up for a rainy day. It is even wiser to save up and save even more by getting tax relief. You can choose to save using your savings account and earn a meagre interest or pay into an approved pension scheme and attract substantial tax relief.

I believe keeping this simple would help you understand the tax benefits of paying into an approved pension scheme.

In simple terms, every £80 you pay into your pension, you end up with £100 in your pension pot.

Imagine if banks started doing that with your savings account, SIGH.

Examples are always the best way to explain so here goes:

If you are a basic rate tax payer and invest £8000 in to your pension. The government will add £2000 and make it a total contribution of £10,000.

If you are a higher rate tax payer i.e. pay tax at 40% and invest £8000 in to your pension. The government will add £2000 and make it a total contribution of £10,000. You can also claim a tax relief of another £2000. Therefore a £10,000 pension pot would effectively cost you £6000.

The annual contribution limit for 2020/21 is £40,000. There are carried forward options available that I will not discuss here to keep the simplicity.

In summary, In 2020/21, if you are a higher rate tax payer and contribute £32,000 in to your pension the government will add another £8,000 and you will end up with a pension pot of £40,000. You will also claim another £8,000 in tax relief that could be claimed through your self-assessment and the same pension pot of £40,000 will cost you £24,000.

Was the merchant right about small gift for a wise investment? I will let you decide….

Please note: This doesn’t not constitute as tax advice. Professional advice must be sought before any tax planning. The tax planning may differ based on your individual circumstances.

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