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Act now to catch the pension boat

By Adrian Huston

Making pension contributions can add thousands of pounds to your overall pot simply through availing of your tax relief

Tax saving by way of pension contributions has a cut-off date of April 5 each year. If you want to reduce your 2008/09 tax bill then any pension contribution has to be made by April 5, 2009. Gone are the days of “carry-back” into old tax years.

Some 22 years in tax has taught me that people sure like to leave things to the last minute. In the case of pension contributions don’t wait until the first couple of days of April to make the contribution.

It could end up being processed on Monday, April 6 — this would mean it would count for the 2009/10 year and not the year you wanted (2008/09.)

Different pension companies have their own rules about last-minute contributions around the closing date. Remember also that April 5 this year is a Sunday, so April 3, 2009 is the last working day of the tax year.

Some people might be reluctant to invest in pensions at the moment, given the volatility in financial markets. I can understand that concern, and am in no position to tell you to invest or not to.

Instead I will simply set out the implications of a pension investment and leave you to discuss the merits with your financial adviser.

In turbulent times the tax relief is possibly the thing which will make your pension contribution more attractive.

Let’s assume you are a 40% taxpayer and have £10,000 to spare (“Wouldn’t that be nice” say the other 70% of readers!)

Invest £10,000 in a building society and you have, of course, £10,000 growing there, with the interest taxed each year at 40%. (20% taken off at source and 20% when you declare it to HMRC.)

With pensions you get tax relief when you make the contribution, so your £10,000 cheque gets topped up by £2,500.

This means a gross pension contribution of £12,500 sitting in the pension fund.

The £2,500 was 20% tax relief on the gross of £12,500. You could always work out the tax relief as a quarter of the cheque you write.

When you do your tax return you will get the rest of your 40% tax relief — another 20%. So a tax saving, of £2,500.

When you take into account the cheque you originally wrote for £10,000 this means your pension payments have, in the end, cost you just £7,500.

So ignoring changes in pension fund values, your £7,500 has already grown to £12,500.

That 66% rise in year one is pretty hard to beat. Indeed even if pension investment values dipped this gives you a fair bit of slack to remain in pocket compared with bank savings.

This all means that you should end up comparing depositing money in a building society, and achieving no immediate growth, with putting funds into a pension and achieving 66% immediate growth.

Furthermore bank or building society savings are taxed each year but pension funds grow tax-free.

Pension investments can even be made after you retire — so long as you are under age 75. These are attractive to retired people fortunate enough still to be paying 40% tax. They can even invest in a pension and immediately start drawing the benefits. For them £600 net invested becomes £1,000 in the fund (same as above.)

However those over 50 (soon to be 55) can immediately take out 25% tax-free and buy an annuity with the rest. So they end up out of pocket £450 yet getting a pension bought with a £750 fund. Not bad.

There are limits to what can be invested each tax year, though these are very generous for working people.

You can invest up to 100% of your earnings. Only people earning over £235,000 come up against a limit (which is £235,000 maximum contribution.)

These are the gross figures. So if you earn £100,000 this year you can write a cheque to your pension fund for £80,000. The kind tax people send your tax relief of £20,000 direct to your pension fund.

You will then get further tax relief when you do your tax return. Note that you will not get the full 40% relief on all the contributions since some of your income would otherwise have been taxed at below 40%.

Non-working adults, or indeed children, can invest a gross amount of £3,600 per year (£2,880 by cheque).

If you are thinking about making pension contributions for 2008/09 get a move on. Get the funds ready and have a word with your financial adviser this week, so you don’t miss any deadlines.

Adrian Huston, a former tax inspector, is a director of Belfast tax and accountancy firm Huston & Co — or (028) 9080 6080.

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