5/1/08Don’t get caught by the change in basic rate tax

The basic rate of tax changes on 6th April 2008 to 20p in the pound. Good news?

Of course any reduction in tax rates is good, but in this case, the cut from 22p to 20p is accompanied by the complete removal of the 10p starting rate and an equalisation of the thresholds for tax and national insurance that could result in many people paying more than before.

At the same time, individual pension contributions will actually go up because they are paid net of basic rate tax.

If you are currently investing £390 a month into your pension, the actual value of your investment is £500 a month, because of the £110 added by HM Revenue and Customs, by way of the tax rebate.

From April 6th, your net contribution (if paid by direct debit) will rise to £400 a month, so that HMCR will only add £100 to your pension. On the other hand, higher rate taxpayers will be able to claim an additional £100 tax relief rather than only £90 through the self assessment system, because the claim is for the difference between the basic and higher rate of tax, which will now be 20% instead of 18%.

If, however, you are paying your pension contributions by cheque or standing order and do not increase your payment, then the gross value will fall to £487.50, because HMRC will only add £97.50 each time.

This will also affect the amount that higher rate tax payers reclaim through self assessment, as the claim will be 20% of the reduced amount, or £97.50—more than the £90 reclaimed under the pre-April regime, but less than the £100 that would apply, if the basic contribution had been enhanced to reflect the change in basic rate tax relief.

This may not sound much, but over the years it will add up.

Employer contributions are not affected, because they are paid gross in any event.