From April, the rules applying to carry forward and carryback will change. Carryback will be restricted and carry forward abolished. But following a recent Inland Revenue concession, if it is combined with carryback, carry forward may still be used between April 6, 2001 and January 31, 2002.
These changes represent a classic marketing window of opportunity or race to the deadline, offering many people valuable opportunities to save tax and boost potential income in retirement.
So it is clearly important that financial advisers understand the current situation and make sure that clients can make the most of it. It is a complicated area where IFAs can really add value and it should be an integral part of any pension healthcheck.
In simple terms, the carryback and carry forward arrangements allow people to catch up on pension contributions that could have been paid in previous years but were missed. Few people pay the maximum level of contributions on which tax relief is available each year.
But as retirement approaches, there may well be an identified need to increase pension provision. If additional funds are available for investment, it may be desirable to pay contributions in excess of the normal limit.
There are two ways in which this can be done and still get tax relief on the whole contribution:
Carry forward of unused tax relief from previous tax years.
Carryback of contributions to a previous tax year.
Carry forward relies on the individual having unused tax relief in respect of the previous tax years.
If the individual had a source of non-pensionable earnings but made no pension contributions or the contributions made did not reach the maximum limit available in the relevant year, then the amount unused may be carried forward.
Although the principle is simple – that you can catch up on missed contributions and get full, current tax relief – there are a few basic rules which must be followed.
Before unused relief can be carried forward from an earlier year, contributions in the current tax year must first be used to cover the current tax year's contribution limit.
Unused tax relief can only be carried forward for a maximum of six years. This means that the current tax year's limit and unused relief for the previous six years can be covered by a single contribution. This can be extended by a further year if used in conjunction with carryback.
After the contribution has covered the current year's relief, unused relief from earlier years is used up in chronological order, starting with the earliest year.
From 1989/90, the maximum amount payable as contributions to a personal pen- sion plan have differed from those payable to a retirement annuity plan. Therefore, the amount of any unused relief will depend on which type of contribution is being paid. The basis for calculating relief is determined by the type of contributions to be paid in the year to which unused relief is being carried forward.
Tax relief is given on the basis of the tax rates applying in the year in which the contribution is paid or deemed to be paid – not the rates for the years from which the unused relief originates.
Carried-forward relief cannot be set against an employer's contribution to a personal pension plan. Employ- ers' contributions must, therefore, fall within each tax year's maximum contribution level to get tax relief in full. Note that employers' contributions are treated like members' contributions in calculating the relief available.
Although employees pay contributions to a personal pension plan net of basicrate tax, all carry-forward calculations should be done on a gross basis. Contributions allowed in any tax year cannot exceed the amount of relevant earnings in that year, even if there is unused relief from earlier years still available.
Whereas carry forward allows unused relief to be added to a current year's limit in order to get tax relief on a bigger contribution, carry back allows tax relief to be given in a previous tax year rather than the current one.
The basic principle for carryback is that once an election to carry back a contribution has been made, the contribution is thereafter treated as if it had actually been paid in the tax year to which it was carried back.
Thus, the contribution would be set against allowances for that year, including any unused relief carried forward, and tax relief would be given by reference to the rates applying that year.
The basic rules for operating carryback are as follows.
A contribution can normally be carried back only into the previous tax year, that is,a payment made in 2000/01 could only be carried back to 1999/2000.
There is an exception if there are no non-pensionable earnings in the previous year.
In this situation, contributions can be carried back to the year before that – that is, if there are no non-pensionable earnings in 1999/2000 contributions made in 2000/ 01 could be carried back to 1998/99.
The whole or part of any contribution may be carried back as long as there i
s sufficient unused relief in the year to which it is being carried back to cover it.
It is not necessary to first cover the maximum contribution limit in the current year. Once again, the total contribution deemed paid in any year to which carry back of contributions relates cannot exceed the amount of relevant earnings in that year.
Contributions made by an employer cannot be carried back.
Tax relief will be based on a calculation of tax liabilities for the year to which the contribution is carried back – not the year of payment.
However, for self-employed individuals, the carryback election will not actually reduce the liability of the earlier year but will instead reduce the liability of the tax year in which the premium is actually paid.
An election to carry back must not cover contributions paid in more than one tax year.
The time limit for carry back election is on or before January 31 following the tax year in which the premium is paid, that is, a payment in the tax year 1999/00 (April 6, 1999 to April 5, 2000) must have been subject to an election on or before January 31, 2001 to carry back to the tax year 1998/99.
The proposed new rules change the time limit for election and the time by which payment must be made. So from April 6, 2001, a contribution must be paid and an election must be made by January 31 in the tax year in which the payment is made, in order for the carryback to be applied. As an example, looking at the tax year 2001/02, the new rules would require both contribution and election by January 31, 2002 for the contribution to be carried back to the tax year 2000/01.
Carry forward allows the maximum size of a contribution to be increased and carryback allows a contribution to be placed in the appropriate tax year. The objective in each case is to maximise the contributions on which tax relief is obtained and possibly to maximise the rate of that relief.
By using the carryback and carry forward options together, up to eight years' tax relief allowances can (at the current time) be used to cover a large single contribution, that is,a contribution in the tax year 2000/01 can be split (using carry back) and treated as a part payment in 1999/00 and a part payment in 2000/01. Using the carry-forward option, unused tax relief for the six years to 1999/00 (1993/94 to 1998/99 inclusive) can be offset against the 1999/2000 contributions.
As a result, allowances for eight years can be used to cover a single payment. If there were no net relevant earnings in 1999/00, the contribution could be carried back to 1998/99 and so up to nine years' allowances could be covered by using both options.
Carryback and carry forward have always been important pension planning tools, enabling people to boost their retirement income with excellent tax breaks. They have also provided important business opportunities for financial advisers.
The Government's new proposals mean that there has never been a better time – certainly never a more important time – for financial advisers to look at the possible pension planning opportunities with their clients to make sure that they do not miss out on the race to the deadline.