What a carry on!

15/03/2011

Carrying forward any unused allowance can make a huge difference to your pension contributions

The new annual allowance of £50,000 from April is a significant reduction from the previous figure of £255,000 but most in the industry believe it is a big step forward from the convoluted tax relief restrictions for high earners legislated for by the previous government.  A further step forward is the re-introduction of a form of carry forward that will enable tax-efficient pension contributions far in excess of the new annual allowance to be made.

Colin Batchelor, Head of Pensions Technical, Savings uses an illustrative case study to explain how you can carry forward your annual allowances:

William is a successful architect and has built up a successful business on the back of his hard work and ingenuity.  He has been earning a tidy sum from his business and in each of the past five years drawn a salary of £180,000.

He has been a regular contributor to his pension arrangement but because he focused on building up his business, the contributions were not as great as they perhaps could have been.  Just as he was going to significantly increase his pension contributions, the anti-forestalling provisions were introduced in the Budget of 2009.

William decided it would be prudent to use up as much of his special annual allowance as he could and in the two tax years that the anti-forestalling applied he contributed the maximum he could to receive the full tax relief available.

After talking to his financial adviser (Adrian) he is keen to increase the amount that he can pay into his pension arrangement.  His IFA has informed him of a change in the legislation that will allow William to “carry forward” unused annual allowances from previous tax years.  The concept seems simple and William is most interested to pursue this.

Adrian the IFA explains that there is a deemed amount of annual allowance for the previous three years and has worked out a table to illustrate the potential amount that William has available.

The following table sets out just what William has paid in the most recent tax years.

Adrian has also explained that at his current level of earnings William will lose his personal allowance.  He tells him that for the tax year 2011/12 the personal allowance is £7,475 and for every £2 earned in excess of £100,000 he will lose £1 of his personal allowance; by the time his taxable income exceeds £114,950 he will have no personal allowance available.

Regaining unused annual allowances

William asks whether there is anything he can do about this.  He estimates that in 2011/12 he will continue to be a high earner and is on course to receive £180,000 in salary (his total taxable income is also £180,000).

Adrian advises William that if he were to pay a pension contribution of £80,000 that his taxable income will effectively be £100,000 and he will therefore regain his personal allowance.  William then asks about the possibility of breaching the annual allowance as this is set at just £50,000.

A carry forward is the solution to the problem.  William has the potential to make a pension contribution of £140,000.  This comprises the annual allowance for 2011/12 together with the £90,000 of unused annual allowances in respect of the tax years 2008/09 – 2010/11.

Adrian explains that before he can carry forward any unused allowances he must first make use of the annual allowance for 2011/12 (£50,000) then he would use the unused annual allowance for the tax year 2008/09 as this is the oldest.  Adrian explains to William that it may be prudent to spread the unused annual allowances over the next couple of tax years rather than make a contribution of £140,000 in 2011/12.

As his taxable income is £180,000 Adrian suggests that William contributes only £80,000 to his pension arrangement in 2011/12.  This is made up of the annual allowance of £50,000 and £30,000 carry forward from 2008/09.  This means that the taxable income for William will reduce to £100,000 and consequently he will regain his personal allowance.

Tax relief simplified

As William has an earned income of £180,000 he will be paying 50% tax on income exceeding £150,000; on income exceeding £35,000 he will be subject to 40% tax.  By making a pension contribution William will receive tax relief at his marginal rates (50% on £30,000 and 40% on £50,000).

However, because his taxable income has fallen to £100,000 he will benefit from the return of his personal allowance.  On the first £14,950 William benefits from an effective rate of tax relief of 60%, on the next £35,050 he will receive 40% and on £30,000 he receives 50% tax relief.

At the end of the tax year William goes to visit Adrian, his IFA, again.  Adrian explains to William that they can repeat the exercise in 2012. It may turn out to be more tax efficient because the personal allowance is set to increase again (possibly to £10,000 meaning the band of pension contribution benefiting from an effective tax relief rate of 60% increases to £20,000).

In 2012/13 William can contribute up to the annual allowance of £50,000 and carry forward his unused allowance of £30,000 from 2009/10. Again, because his taxable income is £180,000 before the contribution he will regain his personal allowance by making the pension contribution (£80,000) and reduce his taxable income to £100,000.  There is even scope to repeat the exercise again in the next tax year.

By prudently planning the payment of pension contributions over the course of three separate tax years William has, with the aid of the appropriate advice, been able to make sizable pension contribution and in each of the three tax years regain his personal allowance.