The Inland Revenue has recently released its second consultation paper on the introduction of a new simplified tax regime for pensions. If the proposals get the final go-ahead, they will apply to all existing approved pension arrangements. However, the new provisions will not come into effect until April 6, 2005 at the earliest.
In the meantime, most individuals should seek to maximise their pension provision and take full advantage of the favourable tax treatment available to pension arrangements.
The proposed introduction of enhanced protection for benefits accrued prior to the implementation of the new simplified tax regime should mean that individuals can confidently maximise their pension benefits under the current rules without any fear that their benefits will be subject to a recovery tax charge under the new regime.
Making a payment to an approved pension arrangement is one of the few remaining ways that an investment can be made that still qualifies for full income tax relief. Pension planning should therefore be a priority for year-end planning, using appropriate investment opportunities and taking advantage of the reliefs, allowances and exemptions for all members of the family.
Taking full advantage of the defined-contribution tax regime
The defined-contribution tax regime applies to all personal pensions and stakeholder schemes although individuals with retirement annuities continue to be subject to their existing rules. There are a number of key attractions:
In any tax year, an individual aged under 75 may normally contribute up to the greater of £3,600 gross or the appropriate age-related percentage of their net relevant earnings. This percentage varies from 17.5 per cent up to 40 per cent for individuals aged 61 or over on April 6, 2003.
Where an individual is resident and ordinarily resident in the UK and aged under 75, it is not necessary to have a source of net relevant earnings to contribute to a personal pension or stakeholder scheme. In such cases, a contribution of up to £3,600 gross may be paid in each tax year.
It should be remembered that where an individual is employed, has no other source of earnings and is a member of their employer's occupational pension scheme, in certain circumstances they will only be able to contribute up to £3,600 gross to a personal pension or stakeholder scheme under the concurrent contribution rules (see below).
An individual can make contributions on behalf of a member of a personal pension or stakeholder scheme. Any such third-party contribution will be treated as having been paid by the member and will be grossed up for basic-rate tax relief. Additional tax relief will be available only if the member is a higher-rate taxpayer.
This rule makes it particularly attractive for contributions of up to £2,808 to be paid for a child or non-working spouse. The Government will add basic-rate tax relief to the contribution, effectively increasing it by 28 per cent.
Where an individual is a member of an occupational pension scheme and is not otherwise eligible to contribute to a personal pension or stakeholder scheme, a concurrent personal pension or stakeholder contribution of up to £3,600 gross can be paid in 2003/04 provided:
The individual had P60 earnings of £30,000 or less in 2000/01, 2001/02 or 2002/03 and The individual is/was not a controlling director in any of 2000/01, 2001/02, 2002/03 and 2003/04.
The ability to pay up to £3,600 gross to a personal pension or stakeholder scheme may also be attractive to directors of small limited companies who are still able to take most of their income in the form of dividends, with only a relatively modest salary, often below the threshold for tax and National Insurance contributions).
With the reduction in the maximum allowable funding rates under executive pension plans and small self-administered schemes, the ability to pay up to £3,600 gross to a personal pension or stakeholder pension scheme is likely to offer such individuals the most attractive means of providing for their retirement.
More than 40 per cent tax relief
Higher-rate tax relief on a contribution to a personal pension or stakeholder scheme is granted by extending the member's basic-rate tax band by the amount of the gross contribution paid. This can have the effect of providing tax relief at 44.5 per cent where a higher-rate taxpayer pays a contribution which results in all or part of his dividend income being brought from higher-rate into basic-rate tax.
A similar effect will be achieved where savings income or chargeable capital gains are brought from higher-rate into basic-rate tax as a result of a contribution although in these cases the relief will be limited to 42 per cent.
Taking full advantage of basis-year earnings
It is possible to base personal pension or stakeholder contributions on a person's net relevant earnings from a basis year, that is, earnings in one of the five immediately preceding tax years, provided this was not a year when the person was only in pensionable employment. This may enable bigger contributions to be paid in the current tax year.
This could be useful for people who are owner/directors of private limited companies and who are taking their remuneration in the form of dividends to avoid National Insurance contributions.
Members with existing retirement annuity policies
Individuals with existing retirement annuity policies should carefully consider whether they would be best advised to continue to contribute to their retirement annuity or pay contributions to a personal pension or stakeholder scheme. In most cases where the intention is to maximise contributions, a bigger contribution may be paid to the personal pension or stakeholder scheme as bigger age-related percentage contributions are permitted.
But where an individual has earnings considerably in excess of the earnings cap applying to personal pensions and stakeholder schemes (£99,000 in 2003/04) they may be able to pay a higher contribution to their retirement annuity.
A member with a retirement annuity policy may also use the carry-forward provisions that no longer apply to personal pensions or stakeholder schemes and of the more flexible carryback rules. Carry-forward allows an individual who has or intends to make contributions in excess of the normal maximum for the current tax year (or the tax year to which a contribution is carried back) to do so by utilising unused relief from the previous six tax years, earliest years first. The taxpayer will obtain tax relief in the current tax year (or the tax year to which the contribution is carried back) and there will be no impact on tax paid in the carry-forward tax year(s).
A contribution paid in 2003/04 can be carried back for tax relief purposes to 2002/03 (or exceptionally 2001/02) and tax relief will be given in the carryback year provided the contribution is paid by April 5, 2004 and an election to carry it back made by no later than January 31, 2005.
It is important to remember that if an individual contributes to a personal pension or stakeholder scheme during a tax year, the maximum aggregate total contributions that can be paid to a retirement annuity and personal pension/stakeholder scheme will be limited to the maximum based on the personal pension/stakeholder scheme limits.
Private limited companies and occupational pensions
Many private limited companies have year ends of March 31 or April 5. The payment of a pension contribution on behalf of a director is still one of the most tax-efficient ways of extracting profits from a company. Provided that any regular employer pension contributions being paid will not result in the member's benefits exceeding the Inland Revenue maximum approvable limits, tax relief as a business expense will normally be allowed on those contributions in the company accounting period in which they are paid.
Moreover, where a special contribution of up to £499,999 is paid in respect of an occupational scheme member, this will normally be allowed for tax relief purposes in the company accounting period in which it is paid. Where a special contribution in excess of this amount is paid, it will be spread over up to four company accounting periods for tax relief purposes. Again, any such employer contribution must not result in the member's benefits exceeding the Inland Revenue maximum approvable limits and must be justified on the basis of the member's past service.
Members of occupational pension schemes who wish to increase their pension benefits may normally do so by payment of additional voluntary contributions or by contributing to a free-standing AVC.
A member may in total contribute up to 15 per cent of his total earnings from the employer concerned, subject to such earnings being capped at £99,000 in 2003/04 where the member is subject to the post-1989 occupational pension scheme rules. In assessing this 15 per cent limit, account must be taken of any mandatory contributions that the member must pay as a condition of being a member of the occupational scheme and of any AVC or FSAVC contributions that are already being made by the member.
In the past, some members may have been deterred from contributing to an AVC or FSAVC as such contributions could normally not generate any tax-free cash. However, if the new simplified pension tax regime is introduced, AVC and FSAVC benefits should be capable of providing a tax-free cash sum.