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Carry on, don't lose your allowance

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How three-year carry forward can be a valuable pension planning tool

Ian Porter

Ian Porter, Head of wealth management, Alexander Forbes Wealth Management

The annual allowance, which is the maximum amount of pension contributions that can be made by, or on behalf of, an individual in one year, was reduced from £255,000 to £50,000 from April 6, 2011.

It will be held at this level at least until 2016/2017, at which point, indexation may apply. Pension contributions made in excess of the annual allowance are taxed at the individual’s highest marginal rate of income tax. It therefore goes a long way to defining when a pension contribution is tax-efficient and when it is not.

In future, the annual allowance will apply in all years except in a year in which an individual retires on grounds of severe ill health or the individual dies.

Previously, the annual allowance did not apply in the year in which pension benefits were taken (that is, converted to income) but this is no longer the case.

It was recognised that members of defined-benefit pension schemes might inadvertently fall foul of this change in legislation due to circumstances beyond their control, for example, due to salary rises.

In order to help such individuals cope with spikes in contribution levels, a facility was devised to allow unused pension allow-ance under the £50,000 cap to be carried forward from previous years.

This also provides a valuable planning tool for individuals with defined-contribution pension schemes.

Carry forward
A three-year carry forward of any unused annual allowance applies for both DB and DC arrangements, which can be used to offset against any pension contrib-utions in excess of £50,000 in a particular year. Carry forward of unused annual allowance is available from the three preceding tax years.

Action
Plan the use of the three year window to maximise pension contributions, maximise tax relief and minimise tax charges. For this tax year (2011/12), anyone wanting to benefit from any unused annual allowance from the tax year 2008/09 should consider using that before April 5, 2012, otherwise the opportunity to take advantage of that year’s unused annual allowance will be lost.

How it works
Before using the carry forward facility, the following points must be borne in mind:

  • Any tax relievable pension contribution paid as an emp-loyee contribution must be supported by earned income in the year the contribution is deemed to be paid (the maximum tax relievable employee contribution is 100 per cent of earned income).
  • Tax relief is based on the tax position of the individual in the year the contribution is deemed paid.
  • The individual must have had a scheme into which they could have paid contributions in the years from which unused allowance is carried forward.

Stage 1
The first stage is to ascertain if the current year’s annual all-owance has been used up. If it has, go to stage 2. If it has not, carry forward cannot be used.

Stage 2
Look at the oldest available year (the third tax year before the current tax year, so that would be 2008/09 for this tax year) and deduct the pension input amount for that year from £50,000. If this leaves a negative balance, this is treated as zero. A positive balance is carried forward to stage 3.

Stage 3
Look at the following tax year (the second tax year before the current tax year - 2009/10 for this tax year) and deduct the pension input amount for that year from £50,000. Again, a negative balance is treated as zero. A positive balance (or zero, if appropriate) is added to the amount carried forward from stage 2 and the total carried forward to the next tax year.

Stage 4
Look at the following tax year (the year immediately before the current tax year - 2010/11 in this case) and deduct the pension input amount for that year from £50,000. Once again, a negative balance is treated as zero and any positive balance (or zero, if appropriate) is added to the amount carried forward from stage 3 and the total carried forward for use in the current tax year.

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