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Huge relief for stakeholder contributors

For those of you who are familiar with the way higher-rate tax relief is now given on personal pension and stakeholder contributions (see my article of September 20, 2001), here is another twist.

In the right circumstances, it is possible to effectively obtain 44.5 per cent relief on such contributions made by individuals. What are those circumstances? The contributor must have dividend income which is assessable to higher-rate tax. For small private limited trading companies, this can be manipulated by adjusting the dividend/salary ratio, perhaps to create this year as the basis year. In future years, further manipulations can be achieved once the basis year is established.

This is an interesting area of planning for those financial advisers who work in conjunction with accountants.

How does relief at such a high level come to pass? It is all a question of combining the 22 per cent basic-rate tax relief on contributions, which is achieved by paying contributions net of such tax relief, with the 22.5 per cent higher-rate tax liability which is now payable on the grossed-up equivalent of dividend income. (That is, of course, 22.5 per cent of the dividends including the added 10 per cent tax credit.) Simple, isn&#39t it?

It is possible to attract even higher relief (up to, say, just over 51 per cent) if the increase in the basic-rate tax limit caused by the addition of the grossed-up pension contributions also results in a revival of lost children&#39s tax credit but that is just a step beyond the scope of this article.

Let us consider an example. In 2001/02, R McGedden has earnings of £30,000. He also receives dividend income of £10,000. His income position before he makes a pension contribution is therefore as follows:

Earnings £30,000

Dividends received £10,000

Tax credit £1,111

Total income £41,111

Personal allowance £4,535

Assessable income £36,576 made up of:

Earned income £25,465

Dividend income £11,111

Tax on earned income

– £1,880 @10% £188

– £23,585 @ 22% £5,189

Tax on dividend income

– £3,935 @ 10% £394

– £7,176 @ 32.5% £2,332

Total tax £8,103

Actual liability – £8,103

less £1,111 tax credit £6,992

McGedden decides to pay a contribution to a stakeholder pension scheme, net of basic-rate tax relief, of the maximum possible by virtue of his age, which is £4,680, the gross equivalent being £6,000. His revised tax position is therefore as follows:

Total income £41,111

Assessable income £36,576

Split as:

Earned income £25,465

Dividend income £11,111

But he receives a revised basic-rate tax band as £27,520 + £6,000 = £33,520.

Tax on earned income

– £1,880 @ 10% £188

– £23,585 @ 22% £5,189

Tax on dividend income

– £9,935 @ 10% £994

– £1,176 @ 32.5% £382

Total tax £6,753

Actual liability –

£6,753 less £1,1111 £5,642

It can be seen, therefore, that McGedden has received relief as follows:

Relief by deduction

– £6,000 @ 22% £1,320

Reduction in tax liability

– £6,992 less £5,642 £1,350

Total effective relief £2,670

The contribution has thus effectively been relieved at 44.5 per cent (£2,670 = £6,000 @ 44.5 per cent). This particularly high rate of relief is one of the many quirks that have appeared under New Labour in Government. It is important that clients are kept abreast of these new opportunities. Good luck with it.

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