How to take advantage of pension tax rules to boost your spouse’s retirement income.
For families, good financial planning should take account of everyone’s circumstances, rather than focusing on the individual. But while many couples understand this well and are good at jointly taking account of opportunities such as Individual Savings Account (ISA) allowances, they often overlook pensions.
Many doctors are in a good position to capitalise on the pension rules, which can work very well for couples. While new pension tax rules have restricted how much doctors can use pensions to boost their own retirement incomes, many have a spouse or partner who has had limited opportunity to build up pension savings other than their state pension benefits. They may have taken an extended period out of the workplace to bring up children, for example, or have worked part time and not contributed to a workplace pension. If so, it may be possible to take advantage of the pension rules to build up their retirement savings; even better, the tax relief on pension contributions will help you to maximise the value of these savings.
In most cases, UK-resident taxpayers under the age of 75 can contribute as much as they earn each year to their pension up to the annual allowance of £40,000. If they’re not earning at all, they can still make pension contributions of up to £3,600 a year. Moreover, you are entitled to fund these contributions for your spouse, effectively from your joint household income – the money doesn’t have to come from their own personal resources.
Tax relief on pension contributions is paid at savers’ marginal rates of income tax – up to 45 per cent for additional-rate taxpayers (based on the tax rate(s) of the owner of the pension plan, so the spouse in this example). But even if your spouse is a non-taxpayer, they’re still entitled to 20 per cent tax relief on their contributions; that’s even the case if they’re earning nothing at all and you’re paying their entire contribution.
This relief is really valuable. It reduces the cost of a £3,600 contribution for your spouse to just £2,880. And there may be a way to do even better; doctors who employ their spouses – as many in private practice do – and make pension contributions on their behalf in their role as employers should be able to claim up to 45 per cent relief on this cost.
These sort of strategies work very well for long-term pension planning, but they can also be very effective over the shorter term too, particularly where a spouse doesn’t pay income tax in retirement, at least until they reach state pension age.
To see how that works, imagine, for example, Dr Smith whose 55-year-old wife, has not yet made any pension savings. Mrs Smith didn’t work while the couple’s children were in education; now they’ve left home, she is working as a self-employed caterer, earning around £18,000 a year, but doesn’t have access to a workplace pension scheme.
Dr Smith has sufficient disposable income to finance pension contributions for Mrs Smith of £6,000 a year – this costs the couple only £4,800 after Mrs Smith claims 20 per cent upfront tax relief. After five years, when Mrs Smith has reached the age of 60, her pension fund is now worth £30,000, assuming no investment growth at all, but this has cost only £24,000 to build up. Dr Smith is now ready to retire and Mrs Smith is keen to stop work at the same time, but since she isn’t due to receive her state pension until age 66, she decides to cash in her pension benefits.
Of her £30,000, Mrs Smith can take a tax-free lump sum of 25 per cent, or £7,500. She is then able to withdraw the remaining £22,500. This withdrawal is in theory taxable, but since Mrs Smith has no other income until she can claim her state pension, she will not be using her personal income tax allowance – £11,850 – so can withdraw £11,850 in the current tax year and £10,650 in the next, and her tax bill will be zero in both years.
In other words, even with no investment growth at all, the couple are able to generate a £30,000 pension fund from contributions of just £24,000; this is a return of 25 per cent over the five years of saving. Mrs Smith then has a useful tax-free income to exploit until her state pension becomes payable.
These kind of financial planning exercises are of huge benefits to many families, but couples don’t always realise what is possible under the current pension system. For doctors well provided for by the NHS Pension Scheme but with a spouse who has little or no savings, it’s definitely worth exploring such opportunities.
After 13 years of advising doctors and as the only independent financial advisers accredited by the BMA, Chase de Vere Medical’s expertise is truly tailored to the medical profession and stretches beyond the NHS Pension Scheme. Book a free initial consultation with a Chase de Vere Medical specialist and learn how they can support you to make well informed decisions to help achieve your financial and personal objectives.
Content correct at time of writing and is intended for general information only and should not be construed as advice.