It is crucial to appreciate that pension input periods and the tax year do not necessarily match up and that a pension input period does not have to last a whole year. Chancellor Gordon Brown made no moves in the Budget to align these two periods, so it is up to advisers to decide on an individual basis whether it would be beneficial for their client to make such an alignment.
There are two rules, two scenarios and two outcomes for advisers to consider.
The first rule is that a pension input period is simply a recurring period starting from the date money is first paid into a pension after A-Day and can be reset to start from a different date. The second rule is that clients can receive tax relief on pension contributions not exceeding 100 per cent of their earnings and the annual allowance for that tax year, provided those contributions are made in the same tax year as the earnings arise.
These two rules and the overlap between pension input periods and the tax year create two potential scenarios that advisers need to consider. The first scenario is an opportunity for clients to effectively double their pension allowance. Pension input periods, if correctly used, can allow clients to contribute more than the £225,000 annual allowance into their pension in 2007/08 and receive full tax relief.
Consider someone expecting to earn £600,000 this tax year who has earned £225,000 by July and makes a pension contribution of that amount, which is the maximum annual allowance for 2007/08. Let us assume their pension input period ends on April 5, 2008 but they then request to reset it to run from August 1, 2007 to July 31, 2008. Their new pension input period ends in 2008/09 so, provided they do so before April 5, 2008, they can contribute a further £235,000 – the annual allowance for 2008/09. The contribution will have been made in 2007/08 so they will be eligible for tax relief in that year at the highest rate.
The next year, should their earnings be sufficient, they can contribute £245,000 in the pension input period of August 1, 2009 to July 31, 2010.
The second scenario is a risk that making a pension contribution today blows next year’s allowance and wastes part or all of this year’s. Consider a client whose first post-A-Day contribution was made on April 6, 2006. Their first pension input period ended on April 6, 2007. This means the contribution paid in 2006/07, which received tax relief in that year, uses part of their 2007/08 annual allowance. Their later pension input periods will run from April 7 to April 6, which means the current period ends not in the current tax year but in 2008/9, so any contributions made today count against the 2008/09 annual allowance of £235,000.
Unless the input period is changed, the client could inadvertently use up next year’s allowance and lose the opportunity of maximising this year’s allowance.
If clients plan to make contributions significantly greater than £225,000 this year, they should request a change to the pension input period before the current tax year ends. If the pension input period is altered to end before April 6, 2008, contributions will be set against this year’s annual allowance and clients have a full funding opportunity of £235,000 for 2008/09.
For people who plan to make significant contributions, lack of action could limit the funding opportunity. Advisers with clients in this position should take action sooner rather than later. The key issue is understanding the overlap between pension input periods and tax years. Resetting the pension input period can have a substantial effect but the opportunity might not always be available.
The two scenarios create two potential outcomes. Getting this wrong means clients could miss a significant opportunity this year and potentially have to wait a year to get their pension savings back on track. But by careful evaluation, informed decisions and planned actions, clients will be very happy and the value of your advice will have been truly demonstrated.
Colin Jelley is head of tax and financial planning at Skandia.