How to Get Two Bites of The Pension Tax Relief Cake
22 February 2008 Jason Butler APFS, CFP, IMC
Jason Butler of Bloomsbury Financial Planning offers advice on accelerating higher rate tax relief.
While occupational and personal pension schemes are still available, the odds are shortening on higher rate tax relief going the same way as the Dodo. My advice is to grab it while you still can.
Under new pension rules, you are able to personally contribute up to 100% of earned income to a registered pension scheme. The scheme has a limit, above which you would pay tax (known as an annual allowance charge) at a prohibitive rate of 40%. The limit applies to a payment input period which ends in a particular tax year. The limit for 2007-08 is £225,000 and for 2008-09 it is £235,000.
Consider the maximum contribution allowable for someone with taxable earnings arising in 2007-08 of £500,000. They start a pension plan with a payment input period ending on 5 April (although other individuals’ pension schemes may have a different end date).
The new rules, however, allow a scheme member to change the end of their payment input period to a nominated date, provided that it occurs before the first payment input period end date.
Thus, if you were to change the end of your first payment input period to a nominated date of, say, 28 February 2008, you could make a pension contribution before then of £225,000 (gross) in respect of the annual allowance for 2007-08 and a further contribution of £235,000 (gross) on or after 1 March, but before 6 April 2008 in respect of the annual contribution allowance for 2008-09.
The effect of this is to attract tax relief at 40% on the £460,000 of taxable income arising in the 2007-08 tax year. The taxpayer will receive basic rate relief at source so that the net contributions would be £175,500 before the nominated date and £183,300 after it, a total of £358,800 this tax year.
Higher rate relief would be obtained by way of a rebate from HMRC, amounting to £82,800 and payable by either a reduction in the balancing payment due in January 2009 or a cash refund.
From 6 April 2008, basic rate income tax falls to 20%, as does the amount of tax relief given at source on pension contributions. Therefore there is a cash flow advantage to making an accelerated maximum payment now, while it is still 22%. On a contribution of £460,000 gross this will cost £9,200 less cash upfront this tax year than from 6 April 2008.
A WORD OF CAUTION
It is important to note that, should you wish to make pension contributions in respect of any earnings in the 2008-09 tax year, no contributions should be made until the nominated date in 2008 has passed.
In our example, this would be after 28 February 2009. This will ensure that you do not inadvertently trigger an annual allowance charge. It is also imperative to ensure that any new contributions, the value of any existing funds and anticipated investment growth arising between now and when benefits are taken, do not exceed the lifetime allowance limit, which for 2007-08 is £1.6m gradually rising to £1.8m in 2010-11. Otherwise, a tax charge of 55% will apply to any excess taken as a lump sum.
If you are worried about current stock market woes, do not forget that you can hold pension money on deposit, although perhaps the best time to invest in an asset like equities, if your time horizon is long enough, is when it is out of fashion.
The other factor to consider is how long higher rate pension tax relief will be around. The proposed National Pension Savings Scheme, which is aimed at those on average earnings and below, proposes tax relief broadly equal to basic rate (1% of band earnings) but with no provision for higher rate relief.
So there you have it. A neat way of accelerating higher rate tax relief while it’s still available and boosting your retirement nest egg at the same time.