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Wednesday, 27 August 2014

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How to make the most of your pension contribution

The tax year end gives us all a regular opportunity to consider taking advantage of the various tax reliefs and allowances available.

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This year there are some one-off opportunities to maximise pension contributions which arise due to the forthcoming reduction in the lifetime allowance (from £1.8m to £1.5m).

Given the current economic climate, the possibility remains that the Chancellor could look at pensions and scrap higher rate pension tax relief, or restrict it in some way, or maybe reduce the annual allowance further.

Currently, members of UK registered pension schemes can claim tax relief on their pension contributions at their highest marginal rate of income tax.

This means that basic rate taxpayers receive 20 per cent relief, higher rate taxpayers receive up to 40 per cent and additional rate taxpayers receive up to 50 per cent. These levels of relief can obviously be real motivators to contribute towards retirement, so if you are considering making a contribution to your pension, it may be sensible to do this now, in case pension tax relief rules do change suddenly.

The Finance Act 2011 reduced the annual allowance to £50,000. Individuals can make pension contributions equivalent to 100 per cent of their earnings, but £50,000 is the maximum contribution an individual can make each year and still benefit from tax relief. Personal contributions, plus those made by a third party or an employer count towards the annual allowance.

An individual has the ability to carry forward any used annual allowance from the three immediately preceding tax years, but to be eligible to use carry forward, they must have been a member of a registered pension scheme during the tax year to which the unused allowance relates.

You are regarded as a member of a scheme if contributions could have been paid to that scheme, even if no actual contributions were actually made in that tax year. This could potentially enable a contribution of up to £200,000 to be made, providing certain conditions are met.

HMRC recently confirmed a change to how carry forward is calculated for 2008/09, 2009/10 and 2010/11. If more than £50,000 was contributed in either 2009/10 or 2010/11, then any excess is not treated as using up any amount of available allowance from a preceding year. Thanks to this clarification, you could now have more unused allowance available to use, but you must act fast – to benefit from this opportunity, contributions must be made by April 5 2012.

The lifetime allowance reduces from £1.8m to £1.5m on April 6 2012, which limits the amount you will be able to build up in a pension fund without attracting a tax charge, which can be up to a whopping 55 per cent. However, the good news is that people can still apply to HMRC to retain their entitlement to a lifetime allowance of £1.8m. This is known as fixed protection and is available to anyone who believes their pension funds will exceed £1.5m at some point in the future.

One condition of fixed protection is that people must effectively cease contributions or active membership from April 5 2012, which again means it may be beneficial to maximise pension contributions now, before the tax year end and apply to HMRC for fixed protection before April 5 2012.

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