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Carry forward, don&#39t lose your relief

After retiring in April 1996 at the age of 61, I have continued working on a self-employed consultancy basis. My pension amounts to £60,000 a year and I receive a further £12,000 in consultancy income. I am therefore a higher-rate taxpayer.

I am now 64 and have considered ceasing work at 75. I am concerned about the fact that I pay 40 per cent tax on my consultancy income. I believe it is possible to mitigate this by making further pension contributions. Please explain how the relief operates.

Assuming you retired on April 5, 1996, you will have been paid £48,000 in consultancy income up to April 5, 2001. You are entitled to make personal pension contributions of a percentage of your consultancy income. If you fail to make use of the tax relief in the tax year in which it was earned, it can be mopped up in the following six tax years.

This can be achieved by making a lump-sum contribution in respect of the unused relief which can either be relieved against the current or previous year&#39s earnings. If the contribution is relieved against the previous year&#39s earnings, relief in respect of the six years prior to this may be used. So you can actually mop up seven years&#39 worth of relief.

When a contribution is relieved against the current year&#39s earnings, it will be used to reduce the tax for the year in which it was paid. This will also result in payments on account, which will be due on July 31 and January 31 of the following tax year, being reduced.

When a contribution is relieved against the previous years&#39 earnings, the tax relief will be used to reduce the tax due for the current year rather than that due for the previous year. However, the payments on account will not be reduced. In other words, the payments on account will be calculated based on the full tax liability for the current year before taking any reduction brought about by the tax relief for the contribution relieved in the previous year.

If you expect to make contributions in future years, it is possible to make an election to the Inland Revenue for the payments on account to be reduced to take account of these. Care should be taken with this because if the tax that is actually due exceeds that shown on the election form, interest will be due on the excess from the due dates of the payments on account.

You should also note that your payments on account could be reduced below the actual amount of tax due for next year. If this occurs, you will be required to make a final payment of the balance of tax due on January 31 following the end of the tax year.

Based on your earnings to the April 5, 2000, you have unused personal pension relief of £19,200. You may not contribute an amount in excess of your net relevant earnings in the current or previous tax year. For this purpose, these will be taken as £12,000 a year. In order to fully mop up the unused relief, you therefore need to elect for part of the contribution to be relieved against last year&#39s earnings.

If you make a contribution of £19,200, in order to maximise your relief in the short term, you should elect for £12,000 of this to be relieved against your earnings for last year. This will give rise to tax relief of £4,800. This will be used to reduce your total tax bill for the current year. Effectively, you will have been returned the tax that you have already paid in respect of the previous tax year.

The balance of £7,800 should be relieved against the current year&#39s earnings. It will reduce your tax on consultancy income from £4,800 to £1,680. This will already have been met through your payments on account made last year. However, you will need to make payments on account of £840 on January 31 and July 31, 2001.

In the next tax year, having mopped up all earlier years&#39 relief (and, in any case, the facility for this now having been removed) you will only be able to make a contribution based on your actual net relevant earnings for the year. You will therefore be able to contribute £4,800, giving rise to a remaining liability to tax on your earnings for the year of £2,880.

As your payments on account will have amounted to £1,680, you will be required to make a final payment on January 31, 2002 of £1,200. As long as you carry on making contributions of £4,800 a year, your payments on account will settle your liability in full.

From April 5, 2001, personal pensions and the new stakeholder pensions will be subject to slightly different rules. You will no longer be able to mop up unused relief from earlier years. You will, however, still be able to relieve contributions against the previous tax year&#39s earnings, provided you make an election to do so by January 31 of the following tax year. If your earnings were to fluctuate, a new facility will permit you to make contributions based on your highest earnings in the previous five years.


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