A rich retirement: making the most of pensions

Friday, October 14, 2011 | Posted by: Mike Hyland
Categories: Personal, Protecting your wealth | Tags: tax, tax planning, HNWIs, income tax, pensions, IHT, retirement, tax relief, Mike Hyland, high earners, higher rate taxpayer, pension, James Temperley, pension series, pensions changes, pensions carry forward, 50% tax rate, annual allowance

After answering some of the most common pension questions in our post last week, we now consider the recent changes to the rules on pension contributions and how you could make best use of the new rules to provide for yourself and your family.

Getting more into your pension
From 6 April 2011, the annual contribution limit on which an individual can receive tax relief changed to £50,000, or 100% of earnings for those earning less than £50,000. This represented an increase for most high earners, who had previously been restricted to £20,000 per annum, or £30,000 in limited circumstances.

In addition, a new carry forward of unused allowances has been introduced, which allows an individual to add any unused allowances from the past three tax years (assuming they were a member of a pension scheme in this period) to their allowance for the current year.

Since, for this purpose, the £50,000 allowance is treated as applying to the earlier years, this can result in tax relief being received on contributions of up to £200,000 in the current tax year, or potentially £250,000 by undertaking planning in relation to your pension input periods.

The following example demonstrates the effect of the carry forward provisions.
John is a self-employed high earner and has made the following pension contributions in the past three tax years:

 

2008/09	£8,000
2009/10	£10,000
2010/11	£12,000
Total	£30,000

John will therefore be able to receive tax relief on pension contributions of up to £170,000 in the current tax year, calculated as follows:

2011/12 allowance	£50,000
Carried forward from 2008/09	£42,000
Carried forward from 2009/10	£40,000
Carried forward from 2010/11	£38,000
Total	£170,000

These allowances must always be used in the order shown in the above calculation, so the current allowance must be used before any carried forward allowances can be utilised.

Providing for your family
A very effective way of providing for your children or grandchildren is to make contributions to a pension on their behalf. There is no minimum age at which a pension can be started, and annual contributions of up to the lower of 100% of their earnings or £50,000 (or £3,600 for a child with no earnings) can be made. In addition:

• The contributions will receive basic rate tax relief within the pension fund (ie for each £80 you contribute, the taxman contributes a further £20)

• If made as part of a regular pattern of contributions out of your income and not impacting on your overall standard of living, the amounts contributed are likely to leave your estate immediately for inheritance tax purposes, avoiding a potential 40% inheritance tax charge on these funds in future

• Where the child is a higher rate taxpayer themselves, they can claim tax relief at their highest rate of income tax on the contributions made by you

This solution is particularly attractive to some as it allows parents and grandparents to reduce their own inheritance tax exposure without immediately putting disposable funds in the hands of the younger generation, who may or may not use these funds responsibly!

If you were not convinced already, consider this: a contribution to your child’s pension of £3,600 at birth and for each year until their 18th birthday would, assuming annual growth of 6%, provide a fund of around £1.8 million by the time they retire at 65, without any further contributions. This size of fund exceeds the lifetime allowance figure of £1.5 million that will apply from April 2012 so is an exceptional sum in today’s money.

Make hay while the chancellor deliberates
Given that 50% income tax relief on pensions may be short-lived, and that pensions rules seem to change with alarming regularity, now could be a very good time to put a pensions plan into action.

As ever, we would recommend you take professional advice before doing so in order to seek to maximise the benefits and avoid any unnecessary tax charges in relation to your contributions.

For further information visit our Private Clients Pensions page or contact your local pensions specialist.

Pension planning series written by Mike Hyland, Assistant Tax Manager, and James Temperley, Chartered Financial Planner.

You might also find these posts useful:

* Pensions – the tax planning vehicle of choice for high earners?
* Rising school fees? Setting up a trust fund could be more than just educational
* Read more posts in our pension planning series