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On the threshold of retirement

PERSONAL PENSIONS

AND STAKEHOLDER

Tax relief on contributions

The Finance Act 2000 introduced a new taxation regime for personal pensions (including the new stakeholder pensions). Most of the changes were effective from April 2001. This regime does not cover retirement annuity contracts. Under Government proposals, this new tax regime is likely to be replaced with a radcally different structure. The earliest date at which the new structure is likely to be introduced is April 2005. See section on 2002 Pensions Green Paper and Consultation Document (not reproduced here).

a: Contributions up to the earnings&#39 threshold

An individual can contribute up to the earn-ings&#39 threshold (£3,600 gross, £2,808 net, in 2003/04), in a tax year, provided that they satisfy the eligibility conditions. They can do so regardless of:

•Their age – subject to the overall age limit of 74.

•Whether or not they have earnings.

•Whether or not they are in an occupational scheme, subject to certain restrictions.

The employer may also contribute, provided the total of employer and employee contributions fall within the limit.

b: Contributions exceeding the earnings&#39 threshold

Individuals can contribute more than the earnings&#39 threshold but the amount of their contribution will depend on:

•Their net relevant earnings (NREs) in their chosen basis year. This could be the tax year in which the contribution is paid or the year to which the contribution is carried back but an individual could nominate another tax year to be the basis year – see below.

•Their age at the beginning of the tax year. A table of the different rates is in 4.2(b) (not reproduced here).

Question 1

Earnings&#39 threshold

What is the maximum amount that an individual with no net relevant earnings can contribute to a personal pension in 2003/04?

a: £3,600 gross, that is, £2,880 net in 2003/04

b: £3,600 gross, that is, £2,808 net in 2003/04

c: £3,500 gross, that is, £2,730 net in 2003/04

d: £3,600 gross, that is, £2,700 net in 2003/04

c: Basis years

An individual can nominate a basis year for their net relevant earnings.

The basis year can be either:

•The current tax year, or

•Any of the previous five tax years. A basis year can be a tax year before 2001/02.

They must have had net relevant earnings in the basis year. Once they have nominated a basis year, they can make pension contributions based on their NRE in that year, even if their earnings have subsequently fallen. This can continue for five years from the date of the basis year. After that, they can nominate a new basis year.

The nominated basis year can be changed at any time. This is worthwhile if the individual has higher net relevant earnings in a later year.

Example

Judith&#39s net relevant earnings have been as follows:

£

1998/99 56,000

1999/00 50,000

2000/01 33,000

2001/02 38,000

2002/03 44,000

2003/04 43,000

She wants to maximise her pension contributions. If she nominated 1998/99 as her basis year, she could make personal pension contributions in 2003/04 based on her NRE of £56,000.

In 2004/05, assuming the tax regime has not changed by then, she would no longer be able to use 1998/99 as her basis year. The earliest year she could nominate would be 1999/2000.

In 2005/06, assuming the tax regime has not changed by then, the earliest basis year she could nominate would be 2000/01. However, that year is not a suitable nomination because of the fall in her NRE. She would be wise to nominate 2002/03, unless her net relevant earnings in either 2004/05 or 2005/06 turn out to be higher than £44,000.

Advice

An adviser will need to know the level of an individual&#39s net relevant earnings for each of the past five years, to help them choose the most appropriate basis year.

Procedures

Evidence of earnings must be given to the scheme administrator. Evidence for an employee can include a week 52 payslip or a form P60 or a copy of the tax return for the basis year. Evidence for a self-employed person would include a copy of their tax return or business accounts.

QUESTION 2

Personal pension contributions

Judith was aged 55 at the start of 2003/04.Her net relevant earnings have been as follows:

£

1998/99 49,000

1999/2000 32,000

2000/01 30,000

2001/02 44,000

2002/03 42,000

2003/04 43,000

2004/05 28,000

Disregarding any possible changes to the contribution rules, what are the maximum amounts she could contribute to a personal pension in 2003/04 and 2004/05?

•a: £13,200 and £15,400

•b: £14,700 and £15,400

•c: £14,700 and £17,150

•d: £12,900 and £15,050

d: Post-cessation years

Once an individual no longer has net relevant earnings (for example, following retirement), different rules apply.

For the tax year in which earnings cease and the following five tax years, personal pension contributions can be based on the NRE of the nominated basis year. A nominated basis year could therefore justify contributions for up to 11 years.

Example

Peter&#39s earnings ceased permanently in March 2002 when he accepted early retirement. His net relevant earnings were as follows:

£

1997/98 58,000

1998/99 51,000

1999/00 55,000

2000/01 49,000

2001/02 53,000

2002/03 31,000

2003/04-2007/08 Nil

Peter wants to make the maximum possible pensions contributions. In 2002/03, Peter&#39s personal pension contribution was based on £58,000, the NRE of 1997/98 his nominated basis year.

He could continue to use 1997/98 as his nominated basis year for each of the tax years 2003/04 to 2007/08, assuming the tax regime does not change in the interim, making personal pension contributions based on NRE of £58,000.

The “qualifying post-cessation years” (as they are known) would end on April 5, 2008. After that, any further personal pension contributions would be limited to the earnings threshold (currently £3,600).

e: Resumption of earnings after cessation

The post-cessation rules will be replaced by the normal basis year rules if, during this period, the individual:

•Has further net relevant earnings, or

•Becomes a member of an occupational pension scheme for the whole of a tax year.

QUESTION 3

Post-cessation earnings

Alan, aged 62 on April 6, 2003, has NRE as follows:

£

1997/98 33,000

1998/99 30,000

1999/2000 29,000

2000/01 30,000

2001/02 28,000

2002/03 24,000

His earnings ceased permanently in February 2003. Assuming the tax regime has not changed by then, what are the maximum amounts that he could contribute to a personal pension in 2007/08 and 2008/09?

•a: £9,600 and £3,600

•b: £9,600 in each year

•c: £13,200 and £3,600

•d: £13,200 in each year

Answers to Self-test Questions

1: Correct answer: b

The amount of the earnings&#39 threshold:£3,600 gross, £2,808 net in 2003/04.

2: Correct answer: b

Judith is still under the age of 56 at the start of the tax year 2003/04, so the maximum she can contribute during that year is 30 per cent of net relevant earnings. She can use a basis year for net relevant earnings in any of the previous five years.The highest is £49,000 in 1998/99. So she can contribute 30 per cent of £49,000, that is, £14,700.

3: Correct answer: c

The basis year for the contribution in 2007/08 is 1997/98 because he is still within 11 years. He is over 60 and he can therefore contribute 40 per cent of £33,000, that is, £13,200. But his qualifying post-cessation years ceased in 2007/08 and the next year he can just make the earnings&#39threshold – which is currently £3,600.

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