TT109: Pension Contributions

January 22, 2008

Pensions simplification

From A Day (6 April 2006) Pensions Simplification altered all the rules for the various types of pensions that existed and put them into one system. However, there are some transitional arrangements for protecting benefits under the old system (particularly for funds that exceed the maximum lifetime cap of £1,600,000 per person in 2007-08) and most people by now have taken advice from their Pension Advisor to confirm their position.

Applying the rules to maximum benefit

In certain circumstances an interesting use of the rules allows double pension contributions in one year on which an employer can obtain tax relief.

The new rules on contribution limits fall into two categories depending on who is making the contributions:

  1. Personal contributions (by employees or self-employed persons)Contributions are no longer limited by a percentage of earnings and an earnings cap is no longer applied. (Neither is there any longer carry-forward or carry-back of unused allowances.) Contributions are generally unlimited, but tax relief is only available on the higher of the ‘relevant earnings’ of the individual or £3,600 per tax year (provided the scheme operates tax relief at source).  Beware that dividends and other investment income do not count as earnings for this test.
  2. Employer contributionsThese can be made gross by the employer and are generally tax deductible in the company. Spreading provisions exist for large payments of £500,000 or more which may spread the employer’s tax relief over up to 4 years. The contributions are not taxable on the employee.

There also exists an annual contributions limit for each individual. If the total contributions to all schemes come to more than £225,000 in 2007/08 (£235,000 in 2008/09) then the excess is chargeable on the individual at 40%.

It is widely believed that as an individual cannot make a contribution of more than his/her earnings in any tax year, an employer cannot make contributions of more than the employee’s salary and obtain tax relief. This would prove a problem for many owner-managed businesses where the owners take a minimum salary with generous dividends, but wish to have reasonable substantial employee pension contributions made on the owner’s behalf.  This belief is founded on a misunderstanding. Whilst the rules for individuals might indicate a general view by HM Revenue & Customs (HMRC) that there is some sort of cap on contributions when compared to earnings, HMRC has confirmed that so long as the company pension contribution forms part of the overall remuneration package for the employee and has been paid wholly and exclusively for the purposes of the trade, then it will be tax allowable to the company.

How can you get two contributions above the annual limit in one year?

Say, for example, the company had a year-end of 31 December. The directors know that in order to get tax relief the pension contribution must be made in the year and they habitually make a contribution in November each year, based upon the company’s management accounts for the nine months to 30 September.

It is perfectly allowable under the rules for the directors to make a statement to the pension administrator that they regard their annual contributions year to end on 30 November – looking back they calculate that they have remained within the limits for each year.

This means that the directors can make a further one-off contribution in December. This will form the contribution for the following annual contributions year, but as both contributions will be within the one company accounting year then they will advance the tax relief on the second contribution. Whilst they will now have to wait until December the following year they will not be at a disadvantage under the pension rules for bringing forward the contribution and obtaining tax relief twice in one year.

Barnes Roffe Topical Tips:

  • If you believe that you have the opportunity to make contributions above the annual limit in an accounting year then you might consider the above arrangement
  • You should take advice as the calculation can be very difficult
  • You can combine this with extending your accounting period to, say, 15 months long to sweep in cash or profits to allow another contribution and accelerate the tax relief on the pension payment.
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