Warr on...

The date of 6th April 2006, commonly known within the industry as ‘A Day’, saw a reinvention of the wheel so to speak with a whole raft of new legislation. This brought about change on many levels with regard to contribution limits, types of permitted investments and how benefits could be enjoyed.

Detailed below are some of the key changes and the issues or opportunities that arise from them.

Without reference to earnings, any eligible individual may contribute up to £3,600 per annum into a personal pension. Above this limit, contributions are linked to income with individuals being able to contribute, with tax relief applying, up to 100% of earnings, excluding dividends, subject to the annual allowance of £225,000 in the 2007/2008 tax year. Regardless of earnings, employers are not restricted in the level of contributions that may be made. However, employer contributions are not automatically granted tax relief, being subject to the ‘wholly and exclusively’ test. Employer contributions in excess of the annual allowance are permitted, although the annual allowance tax charge applying to these excess payments are such that it is not attractive for many clients and salary in lieu of may be more beneficial.

The old allowable contributions are compared with the new limits in the following table: -

Based upon earnings of £50,000 – Individual contributions

There are many benefits that these new contribution parameters offer: -

Avoid the unexpected

Few people can be absolutely certain when they will retire. Surely the old adage of ‘making hay whilst the sun shines’ can now be adopted. Advance funding avoids ill health, redundancy, business downturns and other unforeseeable factors preventing an individual funding for their retirement in later years.

Avoid the Chancellor changing his mind

Legislative changes may effect the ability to fund larger contributions in later years or make it less attractive. For example, if pension contributions became compulsory, the case for granting tax relief to incentivise pension provision may be weakened. It has often been mooted that higher rate tax relief may be withdrawn.

Cost of delay

As evidenced below, investing contributions earlier means that any investment growth applying increases the resultant pension fund. Why fund a retirement through higher contributions when simply making them earlier will cost less? Put in a different context, if a client were seeking to buy a new home for example, would they rather pay £211,154 or £150,000 for the same house? In the new regime, funding can commence all the more earlier, thus saving significantly on the cost of retirement provision.

Assumed normal retirement age 60 – 1% per annum annual management charge – 7% per annum growth rate.

Best of both worlds

These new rules permit clients to enjoy the benefit of dividends and put aside retirement provision. Furthermore, an individual can enjoy an improved cashflow rather than funding from existing personal income.  The effect of making a pension contribution is to extend the basic rate tax threshold by the gross amount. Based upon a salary of £5,225 in the 2007/2008 tax year, a contribution of £5,225 may be made, thus extending the basic rate allowance by the same. Therefore, an additional net dividend of £4,702.50 (£5,225 gross) may be withdrawn without incurring a higher rate Income Tax liability. However, the cost of making the pension contribution of £5,225 gross net of basic rate tax relief is only £4,075.50. Therefore, £627 additional personal income may be enjoyed. This could be retained or instead redirected into an alternative saving vehicle such as an ISA to fund further retirement provision at no further cost from existing personal income.

As can be seen, the new limits offer many benefits to clients.