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Pension contributions under new tax rate

By Raymond Mulligan

Q : I own my own company and will earn in excess of the new tax rate threshold of £150,000. I have been reading that my pension contributions are now restricted. Can you clarify the position and advise me what to do.

A: The budget last month dealt a severe blow for a certain category of individuals, namely those who earn in excess of £150,000.

This group will see the introduction of a new tax rate, the reduction of tax free allowances and a capping of tax relief available from pension contributions.

It is important to bear in mind that this new regime will affect people whose total income exceeds this amount, not just those who are earning in excess of £150,000.

So added to your earnings will be any investment income, rental income or things like benefits in kind such as company cars etc. In other words it means your total income upon which income tax is liable.

The impact for you happens in two stages. Firstly from 2011 onwards, tax relief granted via pensions will be restricted for people who earn in excess of £150,000.

Once your income exceeds £180,000 tax relief, which up until now has been at 40%, will be restricted to 20%.

For anyone who has income between these amounts, the tax relief granted will be tapered somewhere between 40% and 20%.

The more immediate stage happens between now and April 2011. The chancellor in his budget announced that with immediate effect if your overall income exceeds £150,000 then you may have to pay a personal tax charge on any contributions over £20,000.

In the current tax year, this tax charge is equal to 20%. This immediate capping is in place to prevent one off payments being made ahead of the new rules that will come into effect in 2011.

In reality however it has caused chaos in terms of the planning opportunities for those seeking to build up a retirement income.

The one concession that was made was that if you have been paying above the £20,000 pa on a regular basis (regularly means monthly or quarterly) then you can continue making these contributions without any tax consequences.

The problem with this however, is that the majority of individuals make annual contributions to top up their arrangements, and effectively these one off payments will now be ruled out.

The capping of contributions includes contributions made by an employer so again; this has some far reaching implications.

If, for example, your employer made a contribution based upon a percentage of your salary, then any increases in income are likely to be non pensionable. Otherwise you may find yourself paying tax on money you haven’t even received.

So for this tax year and next, my advice would be to maximise your pension contributions as much as possible and thereby claim as much tax back as you can.

In doing so however, you should be careful that you do not trigger any of the unwanted tax traps that have been described above.

It is important that you carefully calculate how all these changes affect you, and have someone independently give you advice on how much can be paid and when it can be paid by.

Equally as important are the other implications going forward of paying tax at the new 50% rate, and seeing what tax breaks you can utilise.

Finally, remember that while these changes have taken place with immediate effect, all this needs to be passed by the Finance Bill in the summer, and there may be some changes made between now and then.

Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, please contact or (028) 9022 1010

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