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Use it or lose it

SPECIAL REPORT: PENSIONS. Winterthur Life strategy manager Mike Morrison looks at life after carryback and carryforward.

This is the first end of tax year since A-Day and for the first time in many years we do not have to think about carryforward or carryback of pension contributions.

In some ways. this is good as I never fully got to grips with the complex calculations but they were a useful mechanism for some, particularly the self-employed, who may not yet know how much they have earned in a particular year.

Are there still some things that need to be done before April 6?

Effectively, there is no limit to the level of pension contribution that can be paid to a registered pension scheme but there is a maximum amount of tax relief that is available in a tax year. This maximum is related to the annual allowance which is set by HM Treasury each year.

For the first five years of the new pension regime, the annual allowance has been set by the Treasury as follows It will be reviewed at the end of this period.

Tax year Annual allowance
2006/07 £215,000
2007/08 £225,000
2008/09 £235,000
2009/10 £245,000
2010/11 £255,000

If the total contribution paid by an employee and/or an employer on the employee’s behalf exceeds the annual allowance, then an annual allowance charge of 40 per cent of the excess will usually apply. This liability will fall on the individual and be collected under self-assessment.

Anyone can pay up to £3,600 gross, irrespective of earnings with the maximum individual contribution being limited to 100 per cent of earnings. An employer can pay in an amount up to the annual allowance if it can be shown to be “wholly and exclusively” a business expense.

In a defined-contribution scheme, the calculation of the annual allowance is the total amount of contributions received by the scheme in the last tax year.

In a defined-benefit scheme, it is the increase in the annual rate of pension multiplied by a factor of 10.

If a client can make further contributions in a tax year, it might be worth considering where those contributions can go. Before A-Day, if an individual was a member of an occupational pension scheme, then that individual could not pay into a personal pension scheme.

Since A-Day, we have full concurrency so any extra contributions could be paid into a personal pension or a Sipp. This might be useful to diversify investments and for future flexibility in drawing benefits.

For any clients who have very high earnings and who want to make big pension contributions in excess of the annual allowance, perhaps in preparation for early retirement, it might be possible to use different pension input periods.
For money-purchase schemes, including personal pensions, the first pension input period starts on the day that the first contribution is made, either by an individual or by an employer on his behalf.

The first pension input period does not have to last for a full 12 months and can end at an earlier date. The earlier “nominated” date can be decided by the individual or the scheme administrator.

In a number of cases, this could well be the scheme’s accounting date but otherwise can just be a date closer within the next 12-month period.

A pension input period does not need to run concurrently with the tax year. It is the amount paid during the pension input period ending within the tax year that is relevant and that will be tested against the annual allowance. I have set out an example in the box here to illustrate this point.
The end of the tax year is the time when many people are getting bonuses or negotiating salary increases. This could be the time when such changes in remuneration are documented as salary or a bonus sacrifice, with an employer pension contribution being paid instead.

The benefit is that if the sacrifice is effective, the contributions will be treated as employer contributions and will not be subject to income tax or National Insurance contributions. The employer will also get tax relief on any additional contributions to the pension scheme as usual.

It may also be possible and tax-efficient for some individuals to pay contributions on behalf of other members of the family. Each of those family members would have their own annual allowance and be subject to their own restrictions as per earnings.

Normally, these would be taxed as if the pension scheme holder had paid. Obviously, any inheritance tax implications should be considered carefully.

The new post-A-Day rules do require a use it or lose it approach to pension tax relief as it cannot be carried over to another year.

As an alternative the new rules do allow considerably bigger contributions than the old rules, allowing more flexibility and control over long-term saving and retirement planning.

PENSION INPUT PERIOD EXAMPLE

David earns £440,000 in the 2006/07 tax year. He decides to make a contribution of up to the annual allowance £215,000 (gross) on January 10, 2007.

Subsequently, he nominates March 10, 2007 as the date of which his first pension input period should end. This means that this first contribution will be tested against the 2006/07 annual allowance as the first pension input period finished within that tax year.

After March 1, 2007, David makes a further contribution of £225,000 (gross) in the second pension input. This will be tested against the annual allowance in the 2007/08 tax year. Only one pension input period can arise within a tax year.

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