Pensions – it’s not just about retirement!
The generous tax reliefs given to pension arrangements mean that they have long played an important role in countering the impact of high tax rates. However, recent Budgets have placed tighter restrictions on these reliefs, just as the arrival of 50% tax made them more valuable.
Rumours continue to appear that higher and additional rate relief for contributions will be withdrawn, saving the Treasury an estimated £7 billion a year.
The use of pensions in tax planning is most easily divided into two areas: pre-retirement and at-retirement. In practice such demarcation often blurs: benefits, particularly tax-free lump sums, may be drawn before retirement and pension contributions may still be made after work has ended.
Your personal contributions to a pension normally qualify for income tax relief at your highest rate(s). Pension contributions reduce your taxable income, unlike venture capital trust and enterprise investment scheme relief (see ‘The tax factor in investment structures’), so can help you to avoid phasing out of the personal allowance or straying into the additional rate tax band.
The rules on the maximum contributions that qualify for tax relief are complex and have changed significantly this tax year.
Very broadly speaking, there is an overall ceiling (the annual allowance) of £50,000 each tax year for contributions (actual or deemed) from all sources. If this threshold is exceeded, full tax relief may still be available if total contributions have been under £50,000 in any of the previous three tax years.
As a consequence, the end of this tax year could mark the last chance to exploit unused relief dating back to 2008/09. If this could be relevant to you, then seek professional advice as soon as possible – the calculation of carry forward of unused relief can be a protracted process.
Whether or not you wish to maximise your pension contributions, it is worth considering how they are made. If you are an employee, then you (and your employer) can save NICs if you make a salary and/or bonus sacrifice in exchange for employer pension contributions. If you pay higher rate tax, the result could be an increase of nearly 18% in the amount being paid into your pension. However, salary sacrifice can have drawbacks, so again, advice is necessary.
Alongside the £50,000 annual allowance, there is also a lifetime allowance (LTA), which effectively sets a maximum tax-efficient ceiling on the total value of your pension benefits. The LTA is currently £1.8 million, but will fall to £1.5 million from 6 April 2012, after which date it is likely to be frozen until at least 2016.
The LTA is subject to three transitional reliefs. You had until April 2009 to claim one or both of the first two, primary protection and enhanced protection. The lowering of the LTA has prompted the arrival of the third, fixed protection, which must be claimed by 5 April 2012.
Fixed protection will allow you to retain a minimum LTA of £1.8 million, but it will normally be lost if you benefit from any pension contributions or further pension accrual after the end of 2011/12. This makes the decision to claim fixed protection far from straightforward, unless you already have pension benefits valued at more than £1.5 million. Fixed protection is another aspect of pensions which may require urgent professional planning.
For example, if you do claim fixed protection, you may also want to maximise pension contributions in the current tax year using the carry forward provisions described above.
In Part 4, we will talk about the decisions you might have to make at retirement – lump sum & income versus taking just an income.