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Contributions

During a 12 month period, there is a maximum amount that can be paid contributed for an individual into registered pension schemes (known as the annual allowance). The accumulative employer and employee contribution in this period must fall within this limit to avoid any tax consequences.

Within this limit, any personal contributions are further restricted to 100% of earnings.  HMRC define UK relevant earnings to mean:

• employment income
• income which is chargeable under Schedule D and is immediately derived from the carrying on or exercise of a trade, profession or vocation (whether individually or as a partner acting personally in a partnership), and
• income to which Section 529 of the Income and Corporation Taxes Act 1988 (ICTA) (patent income of an individual in respect of inventions) applies.  Relevant UK earnings are to be treated as not being chargeable to income tax if, in accordance with arrangements having effect by virtue of Section 788 of ICTA (double taxation agreements), they are not taxable in the Untied Kingdom.

Personal contributions are paid net of basic rate income tax. For example, an individual who’s UK relevant earnings for the tax year are £10,000, the maximum tax relievable personal contribution that can be paid to their pension schemes would be £8,000.  The pension administrators would reclaim the basic rate tax, £2,000 and apply this directly to the pension scheme. 

Personal contributions paid within the stated limits are entitled to full income tax relief. If the individual was a higher rate tax payer they can then reclaim 20% on the gross contribution on their tax return.

A company can also make contributions.  This does not have to be to an occupational pension scheme; an employer can also make contributions to an individual’s pension scheme.  Company contributions receive corporation tax relief and hence are paid gross to the pension scheme. 

Corporation tax relief on company contributions are not restricted to the annual allowance.

However the local tax office has the power to restrict tax relief on company contributions paid in respect of members where:

• any of the benefits which the member may receive from a registered pension scheme are dependant on the non payment of a benefit that the member was expecting to receive from an employer financed retirement benefits scheme.
• payment of benefits to the member from an employer financed retirement benefits scheme would reduce the transfer value of any rights in a registered pension scheme.

The details of when and how such a restriction will take place are set out in the Registered Pension Schemes (Restrictions of Employers’ Relief) Regulations 2005.

The annual allowance is set by the Government, in 2006/07 it was £215,000 and it increases by £10,000 each tax year until 2010/11.  It is important to remember that where the annual allowance limit is exceeded, HMRC will levy tax on the individual on the amount over the annual allowance.

For example: Between 1st April 2007 and 30th March 2008, the total personal contributions made to registered pension schemes was £115,000 and was fully tax relievable as earnings justified the level of contribution.  During this period, the employer also made contributions on behalf of the individual totalling £150,000. Therefore, the total contribution paid in this period was £265,000. The annual allowance for 2007/08 was £225,000.  The member will be taxed at his higher margin of tax on £40,000, the excess of the annual allowance.  The tax relief given on the personal contribution and the employer contribution are not affected.

In short when making contributions, the following should be considered:

• personal contributions are paid net of basic rate tax
• the gross personal contribution should not exceed UK relevant earnings or the annual allowance, whichever is less
• company contributions are paid gross to the pension scheme
• company contributions get unlimited corporation tax relief, but there are exceptions
• the total contributions paid to all pension schemes should not exceed the annual allowance over a 12 month period