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Pension planning

The payment of contributions to an approved pension plan is one of the few remaining ways that an investment by an individual can qualify for higher-rate income tax relief.

The end of the tax year is always a critical date for pension planning to ensure that full advantage is taken of the pension reliefs. This is even more so, given the persistent scare stories concerning the potential removal of higher-rate tax relief.

Many companies also have a year-end of either March 31 or April 5, so an employer contribution to a pension plan can prove to be one of the most effective means of extracting money from the company for the benefit of its directors.

The pension strategies available to clients are diverse.

The introduction of stakeholder pensions on April 6, 2001 was accompanied by the implementation of a new set of tax rules (the defined-contribution tax regime) that apply to all personal pension and stakeholder schemes. These new rules provide a number of tax planning opportunities which can be utilised before the tax year end.

Resident and ordinarily resident in the UK

Any individual who is resident and ordinarily resident in the UK and aged under 75 may normally contribute up to £3,600 gross to a defined-contribution scheme each tax year. The one exception is an individual who is a member of their employer&#39s occupational pension scheme in respect of their only employment throughout a tax year.

This is a major change as previously an individual would have needed a source of net relevant earnings to contribute to a personal pension arrangement.

Children&#39s pensions

An individual may contribute to a personal or stakeholder pension on behalf of another person. Any such contribution will be treated as a contribution by the member of the personal or stakeholder scheme and will be grossed up for basic-rate tax relief.

As a personal or stakeholder pension can normally be set up for any individual resident and ordinarily resident in the UK aged under 75, it will be particularly attractive for a parent or grandparent to make a pension contribution on behalf of their child or grandchild. They could currently pay up to a maximum of £2,808 on behalf of their child or grandchild each tax year.

The Government will add basic-rate tax relief to the contribution which, in the current tax year, effectively provides a free 28 per cent increase to the contribution, bringing this up to £3,600 gross.

It could also prove equally attractive for an individual to pay a stakeholder or personal pension contribution on behalf of their non-working spouse.

Of course, it should be remembered that the contribution is deemed as that of the scheme member. This means that the individual making the contribution cannot claim personal tax relief on the contribution.

Spouses&#39 pensions

If a self-employed person&#39s spouse is not presently working, it may well be possible to implement a strategy that will maintain the net family income but in the process enable a free pension to be provided for the spouse.

Part of the self-employed person&#39s remuneration can be routed to pay a salary to the spouse of just below the threshold for tax and National Insurance contributions, currently £4,524. Naturally, it will be necessary for the self-employed person to justify the remuneration being paid to his or her spouse.

Where the self-employed person is a higher-rate taxpayer, he or she would need to give up £7,540 of their remuneration to provide a £4,524 salary for their spouse. By acting in this way, the net family income will remain constant as the self-employed person would have received a net £4,524, after tax at 40 per cent, based on remuneration of £7,540.

However, the balance of £3,106, which would otherwise be paid in higher-rate tax, can now be used to pay a stakeholder or personal pension contribution for the spouse and, in effect, provide a free pension.

Obtain tax relief at up to 44.5 per cent

Under the new rules, higher-rate tax relief on a personal or stakeholder pension contribution will be granted by extension of the basic-rate tax band by the amount of the gross pension contribution paid. This can result in effective tax relief of up to 44.5 per cent on the contribution where the payment of that contribution results in a part of dividend income falling within the basic-rate tax band rather than the higher-rate band.

Similarly, effective tax relief of up to 42 per cent can be obtained on a personal or stakeholder contribution where this causes part of chargeable capital gains to be taxed at the rate of 20 per cent rather than at the 40 per cent higher rate of tax.

Make full use of the basis year

Under the new rules, personal and stakeholder pension contributions can be based on 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 contributor was in pensionable employment.

Using this facility may enable bigger personal or stakeholder pension contributions to be paid in the current tax year.

Make a concurrent contribution

If an individual is a member of an occupational scheme, is not a controlling director and had P60 earnings of £30,000 or less in the current tax year from their current employment, he or she will be eligible to pay a contribution of up to £3,600 gross to a defined-contribution tax regime scheme.

It should be remembered that such a contribution can only be paid provided that the individual is not otherwise eligible to contribute to a defined-contribution tax regime scheme.

Immediate vesting of benefits

An individual may want to save for retirement but is restricted by a lack of capital to invest. It should be remembered that, for those aged 50 or over, it is possible to make a single contribution to a defined-contribution tax regime scheme and take benefits immediately.

For a higher-rate taxpayer who takes benefits immediately, a contribution of £10,000 would effectively cost only £3,500 (£10,000 less tax relief of £4,000 less tax-free cash from the plan of £2,500). The pension can be drawn immediately even if the individual does not retire. It is, of course, important that account is taken of likely future annuity rates before taking action.

Moreover, if it is wished to minimise a tax liability, it would be possible to use the residual fund, if it is of sufficient size, to secure the minimum allowable income withdrawal payments rather than an annuity. Not only would this minimise the tax liability but also potentially enhance any lump-sum benefits payable on death.

It should also be remembered that, even where the individual no longer has a source of relevant earnings, he or she would normally be able to use the withdrawal to effectively pay up to £3,600 to a stakeholder scheme to provide further tax-efficient retirement benefits.

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