How effective pension planning could help reduce your Capital Gains Tax liability

While your pension fund will likely sit at the heart of your financial plan, a strong strategy should involve all aspects of your finances, including any investments and savings that sit outside your main pension pot.

Different investment types can work together, and, with careful planning, you can utilise the synergy between them to help mitigate your tax liability and boost the fund you have when you retire.

Much of this emanates from the flexibility and tax efficiency of money you pay into your pension fund.

For example, in this article you’ll discover how you may be able to use pension contributions to reduce your Capital Gains Tax (CGT) liability.

Some important pension changes were announced in the chancellor’s spring Budget

One of the biggest announcements made by the chancellor, Jeremy Hunt, in his recent Budget speech, concerned the Lifetime Allowance (LTA) – the total amount you can accrue in your pension fund before incurring a tax charge.

He confirmed that it would be removed in the 2023/24 tax year, and that legislation is to be introduced to abolish it entirely.

There were, however, two other important changes:

• The amount you can save each year into a pension and get tax relief on, known as your “Annual Allowance”, has been increased from £40,000 to £60,000.
• The equivalent annual amount you can pay in if you have already flexibly drawn income from your pension (your Money Purchase Annual Allowance) has also been increased, from just £4,000 to £10,000.

At this stage it’s important to appreciate just how tax-efficient contributions you make to a pension can be: basic-rate tax relief is usually added automatically, so for every £80 you contribute, an extra £20 is added to your fund.

On top of that, you can also claim higher rates of relief at your marginal rate of Income Tax through your annual self-assessment tax return.

There were some previously announced changes to CGT

The ability to pay more into your pension fund is all-the-more important because of recent changes to CGT.

You’re liable for CGT on any gains you make on the sale of assets, such as shares, certain other investments, and any residential property that isn’t your primary residence.

If you do make a gain you have an annual exempt amount that you can use to reduce or mitigate the CGT you’re liable for.

In his autumn statement, the chancellor reduced the CGT annual exempt amount from £12,300 (£24,600 for couples) to just £6,000 (£12,000 for couples) with effect from April 2023.

He also confirmed it will reduce further to just £3,000 for each individual from April 2024.

Using pensions to help reduce your CGT liability

The rate at which you pay CGT is based on your marginal rate of Income Tax.

• If you’re a basic-rate taxpayer, you pay CGT at 10% on non-property assets and 18% on property.
• If you pay higher rates of Income Tax, your equivalent CGT rates are 20% and 28%.

Given this, you can potentially reduce your CGT rate by making a pension contribution in the same tax year as you’ve accrued a CGT charge. This has the effect of extending your basic-rate tax band.

So, not only are you making a highly tax-efficient investment into your pension fund, but you’re also potentially benefiting from a lower rate of CGT on your gains.

A worked example can help explain this

This step-by-step worked example can help illustrate how this could work for you.

It assumes you have employment earnings of £50,000 and have an investment gain of £5,000 above your annual exemption in the same tax year.

Your investment gain takes your annual income into the higher-rate Income Tax band. This means that you will be liable for CGT at 20%. However:

1. You make a pension contribution of £4,000
2. This should automatically be grossed-up with basic-rate tax relief of 20% to £5,000
3. By making the payment you effectively extend your basic-rate band by £5,000
4. This means that all your income and taxable gain fall within the basic-rate band
5. As a result, CGT will only be chargeable at 10%.

This means that, in this example:

• You halve your CGT liability from £1,000 to £500
• You benefit from £1,000 tax relief on your pension contribution.

This example is simply designed to show you the methodology. Your tax affairs are likely to be more complicated, which is why we always recommend that you speak to an expert for personalised advice.

Pension contributions can also help mitigate tax elsewhere

There are other ways pension contributions can be effective to help reduce your tax liability.

Personal Allowance

If your adjusted net income is above £100,000, your Personal Allowance – the amount you earn before you start paying Income Tax – is reduced at the rate of £1 for every £2 you earn.

This means your Personal Allowance is effectively zero if your income exceeds £125,140.

You can reclaim some, or all, of your Personal Allowance by making a pension contribution to take your income to below the threshold at which you start to lose it.

Child Benefit

You’re liable for an Income Tax charge if you or your partner receives Child Benefit and either of you earn more than £50,000 in a tax year.

The tax charge is based on the amount of Child Benefit you receive. If either of you earn in excess of £60,000, the amount of the charge is the same as the Child Benefit received.

Again, by making a pension contribution, you can reduce your net income and, as a result, reduce the tax charge you would otherwise be liable for.

Get in touch 

If you need help or advice regarding any of the pension and taxation issues you’ve read about here or would like to review your long-term financial plan, please get in touch.

Email info@lebc-aspira.com or call us on 01454 632495.

Please note

The information contained in this article is based on the opinion of Aspira and does not constitute financial advice or a recommendation to any investment or retirement strategy.

The figures and information in this article are based on current tax legislation (as of April 2023) and may be subject to change.

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