While £3,600 is generally perceived as the maximum contribution without reference to earnings that can be made to a stakeholder scheme, individuals earning more than the national average can actually pay more
There is a danger that the public may perceive the £3,600 annual contribution that can be paid into a stakeholder scheme without reference to earnings as an absolute maximum. In fact, this only represents the maximum contribution for an individual aged 35 or under who earns less than £20,556.
This means that individuals who earn well in excess of national average earnings (£21,350) can and should pay more. Of course, the percentage of earnings necessary to produce an appropriate level of pension will vary according to existing provision and the availability of other sources of retirement income, among other factors.
As a broad guideline however, the consultant William M Mercer suggests that a total employee/employer contribution rate of 15%-20% of salary is appropriate in the current economic environment. This is at a time when the cost of buying an annuity has been adversely affected by falling gilt yields and increased longevity and when investment returns are also falling.
Clients who want to pay more than £3,600 to a personal pension or stakeholder scheme must base the annual contribution on their net relevant earnings (see Table 1). A 35-year-old who earns £30,000, for example, can pay up to £5,250 per annum, while someone of the same age who earns £40,000 can pay up to £7,000.
Employer contributions, if applicable, must be included in these percentages and the earnings cap restricts the maximum salary on which contributions can be based to £95,400 for the 2001/2002 tax year.
Given the anticipated interest in making contributions to more than one scheme or plan, the Government has made sure there are checks in place to prevent investors exceeding the maximum limits.
David Roberts, a consultant with Watson Wyatt, says: 'When employees take out a personal pension, including a stakeholder, they are required to inform the provider if they are contributing to another personal pension and they must also certify that the total contributions will not exceed the maximum permitted.'
For their part, providers must aggregate the contributions they receive across all of their personal pension schemes ' for example, if they operate a separate stakeholder, basic personal pension and multi-manager plan. However, they are not obliged to try to identify or take account of any contributions made to the schemes of other providers.
Further annual checks are made by the Inland Revenue based on the information providers must report by law.
Roberts explains: 'This information includes, in respect of each member, the national insurance number, contributions paid and, where these exceed £3600, the earnings to justify the contribution. The Revenue then runs a data-matching program from which it identifies potentially excessive contributions that require further investigation.'
Probably the simplest way stakeholder members can improve their pension prospects is to increase the contribution through the employer's scheme via the payroll system.
'Contributions are paid net of the basic rate of income tax, with the pension provider reclaiming that amount direct from the Inland Revenue and crediting it to the member's fund,' says Roberts. 'Members must reclaim any higher rate relief to which they are entitled. They can do this either through their annual tax return or alternatively members may contact their inspector of taxes and request that the PAYE code is amended.'
Some stakeholder schemes actively encourage larger contributions by reducing the annual charge as the fund size grows. Stakeholders that benefit from an employer contribution are attractive but clients who wish to pay substantial premiums may benefit from splitting the amount between the employer's stakeholder and a separate stakeholder scheme or personal pension. This will be an important consideration if the employer's designated scheme offers only the provider's own funds.
So what happens to the tax relief in the case of a second scheme or plan? Margaret Craig, pensions development manager at Scottish Equitable says: 'As with the stakeholder scheme, the personal pension (or second stakeholder) provider will be able to reclaim the basic rate tax relief and add this to the individual's fund. The individual will still be able to reclaim any higher rate relief through the annual tax return.'
Some stakeholder schemes offer an excellent choice of sector funds and include access to external asset managers. However, for the more sophisticated investor, while it might be beneficial to join the stakeholder scheme if the employer makes a contribution, a separate multi-manager personal pension or even a low cost self invested personal pension (Sipp) might prove beneficial from the point of view of diversifying risk. An alternative is to use the stakeholder to build up the fund and then transfer to the Sipp.
'The obvious attraction of using a stakeholder pension as a pre-Sipp nursery arrangement is the absence of any charges on transfer out,' Roberts points out.
The client should expect to pay more for the flexibility to invest in a wide range of sectors, styles and managers but generally speaking, charges for personal pension plans have tumbled in response to competition from stakeholder schemes. However, Martin Reynard, pensions manager at the London firm of chartered accountants Blick Rothenberg, says that these lower charges do not necessarily apply to existing personal pensions.
'Some providers ' Norwich Union and Standard Life for example ' cut charges on existing plans when they introduced their stakeholder scheme but others have not done so, presumably waiting for planholders to find out,' he says.
In these circumstances, the adviser should consider whether it is worth transferring to the provider's new plan or even to another company.
John Turton, head of life and pensions at Bestinvest, says: 'Providers like Allied Dunbar that have cheaper new plans may compensate clients in their more expensive older plans by offering a loyalty bonus that effectively reduces those higher charges if premiums are maintained.'
Of course, there will be providers that have done nothing to improve the charges of older plans and due to the transfer penalties that apply, it may be uneconomic to switch to a new provider.
Turton says: 'Assuming a similar rate of growth ' from a tracker fund for example ' the important issue here is to look at the total charges including the impact of loyalty bonuses and termination penalties. Only then can you decide whether it is worthwhile to switch to an alternative provider.'
Some of the employees offered access to a stakeholder scheme will already have a retirement annuity plan (RAP) ' the predecessor to the personal pension. After July 1988, sales of these contracts stopped but policyholders could continue to contribute to existing plans and there may be good reasons to do so. RAP contribution limits are lower in terms of percentages than for personal pensions (see Table 2) but these older plans are not subject to the earnings cap. Nor were they affected by the withdrawal of the carry back and carry forward rules.
Moreover, depending on the client's age at retirement and the prevailing annuity rates, it may be possible to take more than 25% of the retirement annuity plan proceeds as tax-free cash since the calculation is not a straight percentage of the fund but is instead based on the residual annuity rate. The other main difference between the two arrangements is that a client cannot use a RAP to contract out of Serps nor can the plan be used to take an employer contribution.
Provided the investment performance of the retirement annuity contract is satisfactory and the charges are competitive, it is possible to maintain the plan and still make contributions to a stakeholder scheme or personal pension. However, the interaction of RAP and personal pension contribution rules is complex and it may be necessary for the client to make RAP payments in a year when there is no contribution to any scheme or plan that must comply with personal pension rules.
The public may misinterpret the £3,600 stakeholder contribution as an absolute maximum.
It is important to check charges and terms on existing personal pensions to see if they can be improved.
Care must be taken if the client wants to contribute to both a stakeholder/personal pension and a retirement annuity plan.
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