Benefits from Employment Insurance (EI) are fantastic. When you are between jobs, are laid off, or are on parental leave to connect with your child, EI will pay you.
While this safety net is extremely beneficial to your cash flow, EI may come back to bite you at tax time.
Most of the time, some income tax is taken from EI funds with each payment. Many people believe that sum would “cover” their taxable income and that they will owe nothing extra. However, the amount generally deducted is a significantly lesser proportion than what you will frequently be required to pay on your taxable income for the year.
As a consequence, when it comes time to file your taxes and add your EI payments to your other income for the year, those EI payments will be taxed at a higher rate than what was withheld from the payments.
We see it very regularly with our clients: people owe money on their tax returns in years when they earned EI benefits, whether from being laid off, taking maternity leave, or elsewhere.
So, our warning to you is to be wary of the EI tax trap! If you end up receiving EI payments, you should save aside some money to meet the tax hit that is likely to occur at tax time.
Most persons will be able to make combined employer and employee contributions of up to £40,000 (gross) each year that will be tax-deductible. It is sometimes even feasible to donate more (if you have allowances brought forward). However, the amount that may be given without triggering a tax payment for persons earning more than £110,000 up to April 2021 and £200,000 thereafter is limited owing to the introduction of Tapered Allowances in 2022.
If your employer makes contributions, you may have little say over how much is paid in each year. If your contributions exceed the allowed threshold for your earnings level, you will be liable for repaying the additional tax relief, which may result in an unexpected tax payment at the end of the year.
Tapered pension allowances were implemented in April 2022, and everyone earning more above a specific level of income has their contribution limit reduced. This occurs at a rate of £1 for every £2 of extra revenue.
These regulations evaluate both “threshold income,” which is roughly equivalent to taxable income plus salary sacrificed perks less personal pension payments, and “adjusted income,” which is the threshold income plus employer pension contributions. Until April 2021, if you had at least £110,000 in threshold income AND adjusted income of £150,000 or more, your pension allowances would be tapered for the amount of excess adjusted income. Under these guidelines, the maximum amount of tapering remaining allowed is £10,000
The amounts of wages that are affected have raised to £200,000 threshold income and £240,000 adjusted income beginning in April 2021, therefore fewer people are affected today. The new guidelines, however, include a catch: the maximum tapering may leave you with allowances as low as £4,000. Those with the greatest incomes will thus have very little opportunity to contribute.
Unused brought forward allowances from the previous three years can still be utilised, but only if you were a member of a scheme during those years and there was a used balance remaining.
While fewer people may be affected beginning in April, those who are affected may feel the impact more acutely if donations of £10,000 or more are made to the pot.
If you are subject to tapering and your employer’s remuneration package includes anything more than very modest contributions (or you want to make personal contributions in addition to these), the automatic tax relief that you are deemed to have received from receiving the contribution in the first place may be clawed back. This will happen at a 45 percent rate.
When preparing your tax return, you must ensure that you disclose both your own and your employer’s contributions, and you must keep a record of prior contributions to ensure that you may use any carried forward allowances that are available.
Personal payments may need to be grossed up for basic rate tax depending on the programme you are a part of, and while you may still be entitled to some tax relief, relief on the excess will be withheld and must be returned via Self-Assessment. The clawback is then applied to your tax bill for the year.
So, is it still worthwhile to allow your company to contribute?
Unless your company makes you additional offers of pay, the answer is probably “yes” from a tax standpoint. You are still enjoying the benefit of these payments tax-free, and any growth or profits inside the pension remain tax-free until you draw on them, making this a very tax-efficient option. However, if your workplace has additional options, you may want to examine them after seeking financial guidance on how much you should be putting up for retirement.