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Waiving goodbye

The end of the old tax year and the beginning of the new one is always a time when clients are likely to need help with financial planning, especially in the area of pensions.

The end of the tax year 2000/01 sees the abolition of some important benefits and as such it represents a considerable opportunity for IFAs to help their clients make full use of the current rules to best advantage. However, waiting until after April 5 also deserves careful consideration – as will be explained later.

Carry on contributing

The rules for carryback/ carry-forward are changing. Carry-forward is being withdrawn and 2000/01 is the last tax year in which it can be used. The deadline for those wanting to use carry-forward is April 5, 2001, the final opportunity to make the most of an important benefit that will not be available again.

The changes to carryback are a little more complicated. From 2001/02 onwards, carryback will only be allowed if the contribution is paid before January 31 in a tax year and the decision to carry back is made at the same time as making the contribution (or earlier).

The combination of carryback/carry-forward will mean that a contribution paid in 2001/02 can be carried back to 2000/01. If 2000/01 is the base year then carry-forward can still be taken advantage of.

This means that the absolute deadline for using carry-forward is January 31, 2002, provided, of course, that the contribution paid is carried back.

To illustrate the importance of the timing of the contribution and show how carryback/carry-forward can be used to best advantage, consider the following example. Tom and Jerry are both higher-rate taxpaying self-employed individuals and are planning to make a contribution for the 2000/01 tax year.

Tom makes his contribution just before the end of the tax year on April 5, 2001 and obtains his relief at 40 per cent by having a lower balancing payment on January 31, 2002 – a wait of nine months for all of his relief.

Jerry, however, pays his contribution a day later on April 6 and carries back to 2000/01. Because the contribution is actually paid in 2001/02 this must be paid net of basic-rate tax – even if paid by someone who is self-employed. The rest of the tax relief would be obtained as an offset against the balancing payment due on January 31, 2002 – in other words 22 per cent tax relief immediately and the remaining 18 per cent is received on the same day that Tom has waited to receive all of his relief.

From the above example, it is clear that the choices are:

l Pay before the end of the tax year and wait nine months for 40 per cent.

l Wait a few days until the next tax year starts, receive 22 per cent tax relief immediately and wait nine months for 18 per cent.

Wave goodbye to waiver

Significant changes to life cover and waiver of contribution will also occur at the end of this tax year:

In future, the cost of life cover cannot be more than 10 per cent of the contribution rather than 5 per cent of net relevant earnings as at present. This will really limit the life cover that can be obtained by individuals paying low contributions and cause problems for anyone wanting or needing to reduce future contributions.

The waiver changes are more dramatic.

From April 6, 2001, an individual will no longer be allowed to use part of the pen- sion contributions to fund for a waiver benefit. Contracts in place before then can continue on the current basis provided the plan included a waiver option “even where that option has not been exercised at that date”.

After April 6, 2001, anyone wanting to insure against not being able to afford a contribution due to illness, accident or unemployment will have to take out an unconnected plan which will not obtain tax relief on the contributions.

If the individual uses the benefits from a waiver plan to fund a personal pension they will be able to pay net of basic-rate tax.

These changes mean that higher-rate taxpayers whose earnings cease in the future will lose out on tax relief on the contributions.

Also, anyone paying contributions over £3,600 who suffers a long-term illness – and is likely to have no net relevant earnings – will eventually be limited to only being able to pay £3,600 into their personal pension plan.

Just think of the difference in fund at retirement for someone paying, say, £10,000 a year and making a claim under existing or new waiver. The existing waiver would credit the plan with £10,000 a year potentially through to retirement, whereas under new waiver the maximum contribution to the plan may be limited to £3,600 a year in five years time.

IFAs to the rescue

The year-end choices may be difficult. Will the current rules for life cover be more beneficial for an individual than the rules after April 5?

Should contributions be paid before the year-end to obtain the current waiver rules or will waiting until after the year-end (and carrying back) be more beneficial with better cashflow?

Thank goodness for simplification and for IFAs who can help with these decisions.

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