Are you a Director of Employee and currently paying personal pension contributions? If so, the changes to pension rules introduced just over a year ago could be seriously limiting tax relief on these if you have adopted a policy of taking reduced salary enhanced by dividends.
This will not be an issue for you if you are an existing Sedulo client and you have been advised by our tax team and financial advisers, but if you have any concerns about pensions please feel free to call us.
What’s the full story?
Since April 2011 the tax relief on pension contributions has been limited to an annual maximum of £50,000. If you don’t use the full allowance in one year, you can carry forward the balance to use in any of the following three. That’s more than enough scope for most people, but there are some additional limits to consider.
Net relevant earnings
Where your net relevant earnings (NRE), broadly these are income from employment or self-employment less any interest he pays qualifies for a tax deduction. This is good news for Andrew, but there’s a potential restriction. Gift Aid payments you make for a year, are less than £50,000, your pension contribution limit is capped at the higher of these or £3,600.
Example – John is a director-shareholder of Alpha Ltd. His income from Alpha for the last several years has been a salary of £15,000 plus dividends of £60,000. While his income is above the £50,000 limit, the NRE cap means he can only contribute £15,000 into his pension scheme.
by borrowing against his rental property the
In 2012/13 John paid £25,000 into his pension; this is in excess of his annual limit. But in each of the three previous years he only paid contributions of £3,000. Therefore, he has unused annual allowances to carry forward. John calculates these as £36,000, i.e. £15,000 less £3,000 contributions x three years, and so he’s confident that the £25,000 he paid will qualify for tax relief.
But he’s wrong because the tax allowable contributions that can be made in a year are always capped at the amount of your NRE regardless of any unused allowance brought forward from earlier years.
In John’s case the £36,000 of unused allowances are no use to him because his contribution for 2012/13 already exceeds his NRE of £15,000. His tax allowable contributions are capped at this level, i.e. £15,000. So what are his options?
Refund of contributions
John could ask his pension provider to refund the £10,000 excess contributions. He could then reinvest these next year when he has another annual allowance. However, pension companies are no longer obliged to refund excess contributions and often won’t. Instead, the excess contributions stay in the pension fund and John must report them on his tax return and repay the excess tax relief he’s received.
The simple way to avoid the above problem is to have your company make employer contributions instead of you making them personally. While these count towards the £50,000 overall annual limit, they are ignored for the purposes of the NRE cap.