This pension trick can slash your tax bill

published 10 June 2014

Do you think income inequality has risen in the UK in the last 30 years? If you read the papers at all, you probably do. You are wrong.

As Matt Ridley notes in The Times, after accounting for taxes and benefits, the average income of the top 20% falls from £78,300 to £57,300. That of the lowest 20% rises from £5,400 to £15,800.

So, the highest incomes are roughly four times the lowest (you can, of course, make the divide wider if you want by going for the top and bottom 10% or 5%). That makes income inequality not worse, but better than it was 25 years go.

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Wealth is a different matter. But that, says Ridley, is purely a matter of policy: in the last 30 years, the government has "encouraged asset bubbles in house prices; given tax breaks to pensions; lightly taxed wealthy non-doms; poured money into farm subsidies; and severely restricted the supply of land for housing, pushing up the premium earned by planning permission for development".

So, it's no surprise that owners of capital have seen their "relative wealth increase". The point is simple: policy might have been working to reduce income inequality, but it has also been working to increase wealth inequality.

The bad news (or good news it depends where you stand) is that none of these policies look likely to change. Instead, the recent changes to the pension rules could work to make the well off even better off both in income and wealth terms.

How? Easy, says John Greenwood in The Daily Telegraph. From 15 April, anyone over 55 will be able to access their pension much as they would, say, a deposit account subject to paying income tax on what they take out.

Say you're over 55, still in work for over 35 hours a week and earning £40,000. You could ask your employer to pay you only the minimum wage and to put the rest of your official salary directly into a pension.

This kind of direct salary sacrifice' means you pay no income tax on the money, but crucially that there is also no liability for employee or employer national insurance (NI) contributions (12% and 13.8% respectively).

That, says Greenwood, means you could then withdraw the lot again, take 25% tax free, pay the income tax (but still not the NI) on the rest and cut your total income tax and NI bill from £9,845 to a mere £4,997.

If you are over 60, you don't have to wait. Part of the new rules allows you to cash in three pots of up to £10,000 each immediately. Sacrifice £30,000 into three pensions, cash them in, and you save again, says Hargreaves Lansdown's Tom McPhail. This time the total bill falls from £6,645 to £2,500.

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.