Maximising the opportunities for pensions tax relief

The recent substantial changes to the rules for accessing money purchase pensions and the treatment of funds remaining on death has sparked increased interest in pension fund provision.

However, the amount of allowable tax relief on the contributions and the extent of taxation of the funds when the individual retires remains an area of change. A clear understanding is needed to ensure tax efficiency is obtained and tax charges are avoided, this way you will be maximising the opportunities for pensions tax relief.

This briefing covers the tax rules for money purchase schemes. A money purchase pension scheme provides an individual with a fund which can be accessed by the individual later in life (usually at 55 at the earliest). Money purchase schemes can also be referred to as defined contribution schemes.

What are the tax breaks and what controls exist? A money purchase scheme allows the member to obtain tax relief on contributions into the scheme and tax free growth of the fund. If an employer contributes into the scheme on behalf of an employee, there is generally no tax or National Insurance Contributions (NIC) charge on the member and the employer will obtain a deduction from their taxable profits. However, since 2006 two areas of control were put in place to control the amount of tax relief which was available to the member and the tax free growth in the fund. •

Firstly, a lifetime limit was established which set the maximum figure for taxrelieved savings in the fund(s) and has to be considered when key events happen such as when a pension is taken for the first time. • Secondly, an annual allowance sets the maximum amount which can be invested with tax relief into a pension fund. Amounts in excess of this allowance trigger a tax charge. Relief for individuals All UK residents may have a personal pension and can obtain tax relief on contributions up to the higher of: • 100% of UK relevant earnings or • £3,600. This means that a pension fund can be provided for non-taxpayers such as children and non-earning adults albeit that the tax relief will be restricted to gross contributions of up to £3,600 per annum.

An individual with relevant earnings is entitled to make contributions and receive tax relief on up to 100% of their earnings in any given tax year. However, tax relief will generally be restricted for contributions in excess of the annual allowance. Relevant earnings are primarily trading profits and employment income including taxable benefits but excluding pension income. Property business profits are not relevant earnings for pension contribution purposes with the exception of furnished holiday letting income. Methods of giving tax relief Tax relief on contributions are given at the individual’s marginal rate of tax. An individual may obtain tax relief on contributions made to a money purchase scheme in one of two ways: • a net of basic rate tax contribution is paid by the member with higher rate relief claimed through the self assessment system • a net of basic rate tax contribution is paid by an employer to the scheme.

The contribution is deducted from net pay of the employee. Higher rate relief is claimed through the self assessment system. In both cases the basic rate is claimed back from HMRC by the pension provider. A more effective route for an employee may be to enter a salary sacrifice arrangement with an employer. The employer will make a gross contribution to the pension provider and the employee’s gross salary is reduced. This will give the employee full income tax relief (by reducing PAYE) but also reduces NIC. The employer also obtains income or corporation tax relief which is why owner managed companies often pay pension contributions for director-shareholders. There are special rules if contributions are made to an older style scheme known as a retirement annuity contract.

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