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Retirement Solutions brief: Tale of three city workers

Funding: Clerical Medical financial planning manager Steve Meredith says the timing of contributions is critical to maximise tax relief.

Understanding pension input periods provides significant opportunities for tax-relievable contributions but you need to be clear about how they work or clients can face hefty tax charges.

For tax relief to be obtained on a contribution to a registered pension scheme, the maximum contribution is 100 per cent of relevant UK earnings or 3,600, whichever is higher.

The annual allowance should not be ignored as any pension input which is greater than this may mean that the member will suffer an excess tax charge of 40 per cent.

The following three case studies, involving City workers Ian, Tony and Paula, explain how careful use of input periods can enhance pension planning.

Simplification is not as simple as some would think but a full understanding of the concepts gives opportunities to avoid tax charges and make bigger contributions. Also, the ability to change input periods gives high earners the opportunity to invest earlier than otherwise would be the case.

Case Study 1

Ian earns 250,000 in 2006/07. A tax-relievable contribution would be any amount up to 100 per cent of his earnings. However, any pension input for 2006/07 of more than the annual allowance of 215,000 would give rise to an excess charge.

An input of 250,000 would mean an excess of 35,000, giving Ian a tax liability of 14,000. So although Ian could make a relievable contribution of 250,000, he limits his contribution to 215,000.

This seems quite simple but the concept of pension input periods is not so straightforward. A plan that starts on February 15, 2007 will normally have an input period that ends 12 months later on February 14, 2008, in the 2007/08 tax year, and any contribution which is paid to the plan during this input period is tested against the annual allowance for 2007/08 of 225,000. This means that Ian could possibly contribute 10,000 more without an excess charge.

Case Study 2

Tony earns 500,000 a year and has an existing plan (plan 1, with an input period that ends on April 5, 2007) into which he has already contributed 120,000. His adviser assumes that he could therefore increase his contribution by 95,000 to 215,000 without incurring any excess charge. He takes out a new plan (plan 2) on February 15, 2007 for this amount with a single premium.

In fact, plan 2 has an input period which ends 12 months after the start and the contribution of 95,000 is tested against the annual allowance of 2007/08, not 2006/07.

Not understanding this has two possible consequences.

First, in 2007/08, the adviser may assume that Tony could contribute 225,000 to plan 1 without any excess charge. In fact, if Tony contributes 225,000 to plan 1, then his total pension input for 2007/08 will be 320,000. This is because plan 1’s input period ends on April 5, 2008 (in the 2007/08 tax year) and plan 2’s input period ends on February 14, 2008 (also in the 2007/08 tax year). This would mean that Tony would receive a tax bill of 38,000 or 40 per cent of the 95,000 excess over the 2007/08 annual allowance of 225,000.

Second, Tony could contribute significantly more than 95,000 on February 15, 2007 – up to 320,000, in fact. Any contribution to plan 1, which has an input period ending on April 5, will be tested against the 2006/07 tax year, so Tony could contribute a further 95,000 to plan 1. He could then take out plan 2 with an input period ending on February 14, 2008 and contribute 225,000.

Earnings of 440,000 in 2006/07 are necessary for all these contributions to be relievable as all have been paid in the 2006/07 tax year but this is no problem as Tony earns 500,000.

It is, in fact, possible to contribute up to 675,000 by April 7, 2007 by changing pension input periods.

Pension input periods do not have to be concurrent with the tax year. Individuals have the right to change them and the input period for a money-purchase scheme can end sooner on an earlier nominated date if the member sends a notice to the scheme administrator.

Case Study 3

Paula starts a plan on February 15, 2007 with an input period normally ending on February 14, 2008. She then makes a nomination to end the input period earlier on February 19, 2007. Paula contributes 215,000 on February 15, 2007 which is tested against the annual allowance for the tax year in which the input period ends, that is, 2006/07.

Paula’s second pension input period now starts on February 20, 2007 and would normally end on February 19, 2008 if no nomination is made. On February 20, 2007, she contributes 225,000 which is tested against the annual allowance for the 2007/08 tax year.

Paula then makes a nomination to end this second pension input period sooner. The nominated date must be in the tax year following the tax year in which the previous input period ended as there must only be one input period end in each tax year for each pension arrangement.

Paula’s nomination ends the second input period on April 6, 2007. Her third input period then starts on April 7, 2007 and ends on April 6, 2008, in the 2008/09 tax year. Any contribution paid between April 7, 2007 and April 6, 2008 would be tested against the 2008/09 annual allowance.

The ability to change input periods means that Paula could pay 215,000 now, 225,000 a few days later and 235,000 on April 7, 2007 – a total of 675,000.

In Paula’s example, although pension input periods end in three different tax years, two of these contributions totalling 440,000 (215,000 and 225,000) are paid in the 2006/07 tax year and earnings of 440,000 would be required for these contributions to be relievable.

Also, earnings of 235,000 are required in the 2007/08 tax year for the contribution paid on April 7, 2007 to be relievable.

A fourth contribution would not be possible before April 7, 2008 without an excess charge, unless benefits are taken in full in which case the annual allowance will not apply.


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