Take a pension tax break

by Neil Davis of Armstrong Watson

Last updated 09:25, Wednesday, 27 August 2008

In recent articles my colleague Derek Baty has covered issues ensuring pension investments are suitable from a risk Investment basis, the importance of funding adequately, and the “Open Market Option” when trying to secure maximum income at retirement.

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Time to consider: By 2012 there may be a new type of compulsory pension scheme introduced by the Government. Make sure you are prepared

This article takes a look at some of the tax breaks when contributing to an occupational pension, group-sponsored employer scheme, or an individual arrangement.

I will look at some of the tax planning opportunities that pension contributions can offer.

It is anticipated that by 2012 there may be a new type of pension scheme introduced by the Government.

This is likely to be a compulsory scheme. Until then you may be able to continue contributing to an employer occupational pension scheme where tax relief is given at source up to an individual’s marginal rate.

If you don’t have access to an Employer’s Occupational Scheme, you may have access to an employer-run Group Personal Pension (GPP). If not, a Personal or Stakeholder Pension Contract will be available to you.

Contributions to your own or employer GPP attract tax relief at basic rate (20 per cent). Even if an individual does not pay tax, for contributions up to £3,600 per annum, or 100 per cent of an individual’s earnings, tax relief is still given at basic rate. The difference between basic and higher rates can be reclaimed through self-assessment.

In simple terms, a contribution of £80 per month will have £100 credited to the pension account, an effective uplift of 25 per cent of the contribution.

The higher-rate taxpayer will be able to claim a further £20 – an additional 25 per cent of the initial contribution made through their annual tax returns.

The overall effect is tax relief of either 20 per cent or 40 per cent.

Where an individual is employed by a small company and enjoys a reasonable salary or bonuses, they could look to enter into an arrangement with the employer whereby they forego certain bonuses or salary, and pay reduced national insurance contributions (NIC) and income tax on the balance of their salary.

In return, the employer could make an additional pension contribution in line with amounts given up including NIC saved by them. The net effect is an increase in pension contributions and usually no loss of net income.

For those self-employed, who have incorporated, employer pension, contributions attract tax relief of at least 21 per cent. In addition, pension contributions can be a useful method to extract dividends from the business and avoid paying higher rate tax on them.

Other planning opportunities could include parents/grandparents making pension contributions on behalf of children/grandchildren. Contributions are credited with basic rate tax relief and the benefactor, where applicable, could reclaim higher rate tax relief through their returns. Contributions made may even be exempt from Inheritance Tax if made within the annual gift allowance.

It might just be the time to dust down those old policies that you have either stopped contributing to, or have just simply chosen to maintain contributions to, without having them reviewed by a professional adviser.

Armstrong Watson has suitably qualified advisers to help with all aspects of retirement planning.