How can we best spread our pension?

10 April 2013

Q

I pay higher-rate tax and my wife pays the standard rate. When we retire, I expect to pay the standard rate on my pension, while my wife may or may not have enough pension to pay tax on. At the moment, we are paying extra contributions into a personal pension to make sure her pension is above the personal allowance. Is it better for me to make extra contributions into my own personal pension and get an extra 40% back as I am a higher-rate taxpayer, then pay 20% tax on the pension when I take it? Or is it better to continue to make the extra contributions into my wife's pension, probably pay 20% tax on some of the pension when she receives it, but miss out on the refund of part of my higher-rate tax payments?
From
CH/Stockport

A

On the face of things, it seems it would be better to invest in a pension and benefit from income tax relief at 40%, your marginal rate, than for your wife to invest and get 20% income tax relief, which is her marginal rate.

However, it isn't quite that simple.

As well as considering the amount of initial tax relief you will get, you need to think about the tax to pay on the proceeds of your pension. Most personal pensions will allow you to take 25% of your pension fund as a tax-free lump sum, although the rest is then taxable as income.

You therefore need to consider what rate of tax you and your wife are each likely to be paying in retirement. You should take account of your pensions, other investments and your entitlement to the state pension.

Higher earners might also have to give some consideration to annual and lifetime pension allowances, which determine how much can be invested tax efficiently or held tax efficiently in your pensions.

Find the best annuity rate for your circumstances

You are quite rightly looking to ensure your wife uses her full personal income tax allowance in retirement, this being the amount of income she can earn before paying any tax. Bear in mind that the government is intent on increasing the personal income tax allowance to £10,000.

Even with this higher allowance, your wife might get quite close to this with little more than her state pension entitlement. You can each order a state pension projection, although from 2016, a new ‘universal' state pension may be in place.

So when investing in pensions, you should ideally aim to get more tax relief on contributions than you will pay on the proceeds. Achieving this might depend on whether, in retirement, you are likely to be closer to the higher-rate income tax threshold or your wife is likely to be closer to the basic-tax rate threshold.

You might be able to adjust your respective incomes by moving cash savings, investments or other assets from one of you to the other.

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