Pension contributions

There are many opportunities for pension planning but the rules can be complicated. Furthermore the rules on the taxation of pensions changed very significantly in April 2006. The new regime includes a single lifetime limit (initially set at £1.5 million) on the amount of pension saving that can benefit from tax relief as well as annual limits on the maximum level of pension contributions (initially set at £215,000).

Tax relief is available on pension contributions at the taxpayer’s marginal rate of tax. Therefore a higher rate taxpayer can pay £100 into a pension scheme at a cost of only £60. Indeed for some individuals, in particular where income consists largely of dividend income, the marginal rate of tax maybe as high as 44.5%. For such an individual the true cost of a £100 pension contribution is £55.50. With the inability of the state to provide adequate levels of retirement pensions widely acknowledged, it is more important than ever to provide for a secure old age.

All individuals, including children, can obtain tax relief on personal pension contributions (not retirement annuity premiums) of £3,600 (gross) annually without any reference to earnings. Higher amounts may be paid based on net relevant earnings (NRE).

Individuals can make pension contributions of up to 100% of their NRE in a tax year. One of the significant changes under the new regime is that contributions must be paid during the tax year. There is no facility to carry contributions back to the previous tax years.

Directors of family companies should, as an alternative, consider the advantages of setting up a company pension scheme or, alternatively, arranging for the company to make employer pension contribution. If a spouse is employed by the company consider including them in the scheme or arranging for the company to make contributions on their behalf. Even with modest salary levels, significant benefits can accrue.