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Contributions

In October the Treasury confirmed that they will be dramatically reducing the annual allowance for pension contributions from £255,000 to £50,000. They also confirmed that the lifetime allowance will be cut from £1.8m to £1.5m; however this change will not be coming into effect until 2012. Along with these changes the Treasury has decided to scrap plans to bring in special annual allowances, which would have restricted higher rate tax relief on pension contributions for those with gross income of £150,000 or more, and relevant income of £130,000 or more. Also you still cannot get tax relief on contributions that exceed 100% of earnings.

However the Government has made the point that people who make one-off larger contributions will not be at too much of a disadvantage as they will be able to use unused allowances from previous years, over a 3 year period. Therefore in the Treasury’s terms “protecting individuals on low and moderate incomes as far as possible”. This will be known as the three year carry forward rule.

The three year carry forward rule

The carry forward rule in essence allows you to back track to the last 3 tax years in order to use up any unused allowances. However if you are carrying forward unused allowances from the tax years 2008/09, 2009/10 and 2010/11, which you can rightly do, you must remember that the annual allowance that HMRC will be using will be £50,000. Therefore if you have contributed less than £50,000 in those tax years you will be able to carry forward those amounts to increase your annual allowance for the tax year 2011/12. You will however have to use up your annual allowance in a stringent order, using your allowance for the current tax year first, followed by the previous 3 years starting with the earliest

Example 1

So how much can this client contribute with a pension input period ending in the tax year 2011/12?

Firstly, this client will have their annual allowance of £50,000 for the tax year 2011/12. They can then carry forward unused allowances from the previous three tax years, going back to 2008/09. As discussed earlier, HMRC use an annual allowance of £50,000 for the previous tax years. Therefore looking at the table, we can see that in addition to the £50,000 annual allowance in 2011/12, the client will firstly be able to carry forward £40,000 from the tax year 2010/11. If the client uses this up they could then carry forward £30,000 from 2009/10 and finally £15,000 from 2008/09. This means that the overall amount the client could contribute would be £135,000 with full tax relief in the tax year 2011/12. 

Example 2

What happens if a client contributes more than £50,000 in one of the carry forward tax years?

This example is very similar to the first example; however the client contributed £70,000 in 2009/10 instead of £20,000. This does not only affect the 2009/10 tax year but also affects the annual allowance for the 2008/09 tax year as they contributed more than £50,000. As they contributed more than the annual allowance the client would have had to use up their remaining annual allowance in the 2008/09 tax year. In theory the client would have only been able to carry forward £15,000 from 08/09 however the actual annual allowance for that tax year was £235,000. £50,000 is used as a theoretical annual allowance in respect of the carry forward rule. So in conclusion this client will have an annual allowance of £90,000, £50,000 from 11/12 and £40,000 from 10/11.

Mar 30, 2011