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Get back to basis

Clerical Medical retirement planning manager Steve Meredith says the new year brings important pension opportunities with the end of carryback and basis years

Nothing grabs the attention better than a deadline and January 31, 2006 is an important date in the financial calendar which provides opportunities.

First, it is the final date for submitting the 2004/05 self-assessment tax return. Missing this deadline results in an automatic penalty of up to 100.

Second, it is the final date on which the balance of the 2004/05 tax bill is due.

Third, and perhaps most important, it is the final opportunity to make a contribution to a personal pension plan and take advantage of the carryback rules before they disappear.

As well as all this, basis years also cease to apply at A-Day. Currently, a contribution to a personal pension can be based on the earnings in the current tax year or any one of the previous five tax years, provided that the earnings that are used are net relevant earnings.

This effectively means that a contribution paid today could be more than 100 per cent of the current earnings, especially when someone has retired.

At A-Day, the basis-year rules will disappear and it will only be possible to get tax relief on personal contributions of 3,600 or 100 per cent of current earnings, whichever is the higher.

Carryback and basis years can be used together, so it is worth checking to see if there is a basis year that could be used to justify a higher contribution.

For a contribution to be carried back to 2004/05, the earliest basis year that can be used is 1999/2000.

For a contribution for the current 2005/06 tax year, the earliest basis year that can be used is 2000/01.

Some individuals will take the view that carryback is no longer an opportunity and is not required as the contribution that will be possible after A-Day will be up to 100 per cent of earnings with full tax relief and no tax charges if the pension input amount is below the annual allowance.

But the benefit of carryback is the possibility of getting more tax relief and/or quicker tax relief.

Under carryback, the client is asking the Revenue to treat a contribution as though it were paid for tax purposes in the previous tax year.

Carryback does not reduce the previous year’s tax or change the previous year’s assessment but the tax relief is calculated using the previous year’s tax rate(s).

In addition to getting tax relief at the previous year’s tax rates, individuals who were higher-rate taxpayers last year will achieve the effect that the previous year’s tax bill (2004/05) should have been lower and as you are now paying the balance owed on that bill, then you should be allowed an offset against the tax due on January 31.

In example one illustrated at the bottom of this page, 40-year old Ian wants to contribute 5,000 to his pension plan.

He does not need to take advantage of carryback because this contribution is within the maximum that he is allowed to contribute for this tax year. But if he pays a contribution today, he will only get tax relief at 22 per cent, whereas if he carries back to 2004/05 he will get tax relief at 40 per cent.

Example two which is illustrated at the bottom of this page, features 40-year-old Tony who wants to contribute 10,000 to his pension plan.

He does not need to take advantage of carryback because he could either pay 10,000 today or 10,000 after A-Day.

But what are the tax consequences? Any contribution paid for the current tax year or next year will obtain tax relief at 22 per cent, whereas if he carries back to 2004/05 he will get tax relief at 40 per cent.

In example three shown at the bottom of this page, Nicola, who is self-employed and 40 years old wants to contribute 10,000 to her pension plan.

She also does not have to use carryback. She could either pay 10,000 today or after April 5 and obtain tax relief at 40 per cent.

But what are the tax consequences for Nicola? If she makes a contribution in 2005/06 she will get basic-rate relief at source and get the difference between higher-rate relief and basic-rate relief by having a lower balancing payment on January 31, 2007.

A contribution made in 2006/07 will mean a lower balancing payment on January 31, 2008.

But if she carries back to 2004/05, she will get basic-rate relief at source and receive the difference between higher-rate relief and basic rate relief by having a lower balancing payment on January 31, 2006 – immediate tax relief.

The difference between a personal pension contribution paid before January 31, 2006 and after January 31, 2006 is that the contribution before January 31 gives the opportunity for immediate higher-rate tax relief.

If the contribution is paid after January 31, 2006 then carryback will not be possible and the person will have to wait until January 31, 2007 to get the difference between higher-rate and basic- rate tax relief.

Carryback only applies to personal contributions paid into retirement annuities and personal pensions, not to contributions paid by employers on behalf of employees.

Example 1

Ian is 40 years old and has earnings and contribution limits of:

Tax year Earnings Maximum contribution(Taking advantage of basis years)2004/05 50,000 10,0002005/06 30,000 10,0002006/07 0 3,600 (with full tax relief)Example 2

Tony is 40 years old and has earnings and contribution limits of:

Tax year Earnings Maximum contribution(Taking advantage of basis years)2004/05 50,000 10,0002005/06 30,000 10,0002006/07 30,000 30,000 (estimate) (with full tax relief)Example 3

Tony is 40 years old and is self-employed and has earnings and contribution limits of:

Tax year Earnings Maximum contribution(Taking advantage of basis years)2004/05 50,000 10,0002005/06 50,000 10,0002006/07 50,000 50,000 (estimate) (with full tax relief)

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