From next April, you will no longer be able to take advantage of carry-forward as a handy way of mopping up unused pension tax relief. I want to show you how you can help clients scoop up a considerable sum of money, which can increase the size of their pension pots.
“This sounds great, but I've never heard of carry-forward before. What is it?”
Carry-forward lets you make the most of any unused tax relief from the past six years. It is a simple way of allowing you to catch up on past tax benefits. However, there are special rules governing when carry-forward can be used:
Unused relief has to be used from the earliest years first. But you must have used up your relief from the current year before backtracking.
Overall contribution cannot be more than originally allowed in each year, even if there is enough to cover a larger payment.
Tax relief is given on the basis of the tax rates applying in the year in which the contribution is actually paid.
You must have relevant earnings in the year to which the relief is being carried forward and the overall contri-bution cannot exceed the rel- evant earnings in the year carried forward to.
Both the self-employed and the employed can have their unused relief carried forward.
“This could really be useful.I know I don't contribute as much as I should into mypension. Just how much unused tax relief couldI unlock?”
Well, bear in mind that at present you are entitled to pay between 17.5 per cent and 40 per cent of your earnings into your pension each year, depending on your age. As you rightly say, most people woefully under-contribute into their pension. We estimate that a 44-year-old earning between £35,000 and £45,000, who has put relatively little into their pension could be sitting on unused relief of up to £45,000.
Using the above example, the total unused relief to be carried forward works out at £35,709, plus the current year's relief of £9,380.60. This means the total allowable contribution is a massive £45,090.
“But is it worth makinga lump-sum contribution into my pension? I canthink of better ways to spend my money.”
Think of it this way. The tax relief means it will only cost £32,955 for a contribution of £45,090. And consider the benefits of a pension fund. According to Micropal, over the last 16 years the average UK equity fund has produced an annualised return of 15.78 per cent compound.
Over 25 years, the figure is 17.46 per cent compound. If our 44-year-old retired at 60 and invested his £45,090, he would have a fund topping £470,128 in addition to any existing pension, if history repeated itself. And don't forget that the tax relief would greatly reduce the real cost of the contribution.
“OK, I see your point.But I can't afford to stump up this kind of money.”
House prices have soared in recent years, giving many homeowners substantial equity. A remortgage scheme could allow you to pay for a lump-sum contribution to your pension fund.
Many people are significantly underpensioned but have seen a substantial increase in the equity of their home. By freeing part of this equity viaa remortgage, the benefits are twofold – you can increase the value of your pension fund and at the same time benefit froma considerable amount of tax relief, particularly if you area 40 per cent taxpayer.
Any costs associated with remortgaging soon become insignificant when compared with the potential benefits.
“But what does remortgaging involve?”
Remortgaging is a bit like writing a cheque to yourself. But instead of spending the cash on an exotic holiday, you can use it to provide extra security for your future.
For example, Savills Private Finance offers a remortgage scheme that allows borrowers to raise up to 90 per cent of the property's value. The rate is fixed at 5.39 per cent (APR 7.8 per cent) until September 3, 2002, thereafter switching to the standard variable rate currently 7.74 per cent. There is no extended penalty for early repayment or moving to another lender after the fixed-rate period.
You will need to pay £295 as an arrangement fee to the lender, a fee to revalue the property, solicitor's fees and a broker fee of approximately 0.5 per cent. Your present mortgage should be checked to find out if the lender will charge you a penalty to redeem it.
“How can this work?”
The 44-year-old, borrowing the £32,995 on a repayment basis over the 16 years to retirement, at the rate of 5.39 per cent, would need to make initial monthly payments of just £148.20. Current mortgage interest rates are well below the average of 10.26 per cent for the last 16 years.
But even if this level of rate was to be replicated, the mon-thly cost would only be £350.46 and the total payments to the lender would be £67,288 over the 16 years. Compare this with the fund you could build up of £470,128 as shown earlier, and the potential advantages become clear.
“Are there any pitfallsto this arrangement?”
Nothing comes for free. You should remember you cannot take your pension until you reach 50 and that part of the pension will be taxed as income and part – 25 per cent – may be paid as a tax-free lump sum.
However, this may not be the right way for everyone to boost their retirement income and it is therefore important to seek expert advice.
It should be remembered that pension performance may be poor and your property value could fall. But whatever you decide to do, act fast. You only have a few months left to take advantage of carry-forward.