Colin Batchelor finds out what the new tax rules mean for those contributing more than the earnings threshold of £3,600 to their pension
One of the major opportunities in the new DC tax regime is the ability of eligible individuals to contribute up to £3,600 a year to a personal pension regardless of earnings. But what about changes relating to contributions above £3,600 a year.
Such contributions are based on the existing personal pension earnings and age-related limits and must be justified by evidence of earnings. The main change is that an individual must now nominate a basis year, and supply the appropriate evidence, for his/her net relevant earnings (NRE). This basis year may be either the current tax year, or any one of the previous five tax years.
Taking the current tax year 2001/02 as an example, an individual can select the current year or any of the previous five tax years, going back as far as 1996/97, as their basis year. The individual need not be a member of a personal/stakeholder pension scheme in the basis year but must have NRE in the basis year nominated.
A basis year can be before 2000/01, unlike in the concurrency rules, where 2000/01 is the earliest year for consideration.
Looking to the future
NRE for a basis year can be used to justify not only contributions over the earnings threshold in the basis year, but also in the following five tax years. For example, in Table 1, if 2001/02 is nominated as the basis year for 2001/02, this can also be used as the basis year up to and including 2006/07.
A new basis year will then have to be nominated for 2007/08. If 1996/97 is nominated as the basis year for 2001/02, a new basis year will have to be nominated for 2002/03 because 1996/97 will then be more than five tax years ago.
However, there are a few additional points that people need to be aware of:
• It can be seen that evidence of earnings may be only required every six years.
• A new basis year with higher NRE can be nominated if contributions are to increase above the amount justified by the previous nominated basis year NRE.
• Earnings information and evidence already obtained before 6 April 2001 can be used.
• Evidence of earnings has to be obtained for existing self-employed personal pension contributors within 30 days of when the contribution first exceeds £3,600 a year. As a concession, for the tax year 2001/02 only, contributions above £3,600 a year may be accepted, providing the evidence is supplied by 31 January 2002.
• An estimate of an individual's earnings is no longer a requirement.
When calculating the maximum contribution, the individual must use the NRE from the basis year and his/her age on 6 April of the current tax year (or previous year if carry back is to be used).
Table 2 shows the maximum contribution that can be paid. Where earnings are increasing, a new basis year has to be nominated and appropriate evidence of earnings supplied to pay the maximum contribution. If the contribution is not the maximum, it may not be necessary to nominate a new basis year. It is important to note that for high earners, NRE is restricted to the earnings cap that applies to the nominated basis year. It may therefore be necessary to nominate a new basis year and supply appropriate evidence of earnings year every tax year simply to take advantage of any increase in the earnings cap.
A further development, as can be seen in Table 3, is that employer contributions are no longer limited by reference to earnings with that employer. For example, let us consider an individual with three jobs: one where he earns £100,000; one where he is a 20% director and earns £50,000; and one where he is self-employed and earns £10,000. The company at which he is a 20% director can pay up to his relevant percentage of the earnings cap, whereas it would previously have been restricted to the relevant percentage of £50,000.
Another important change, and opportunity, concerns the position when earnings cease. Contributions of more than £3,600 a year can continue for up to five years after earnings have ceased and can be based on the highest level of earnings in the year of cessation or the previous five years.
If someone has been paying in excess of the earnings threshold of £3,600 a year and has relevant earnings in one year but none in the next (the break year) ' and the break year is 2001/02 or later ' they may continue to pay above the earnings threshold for the rest of the tax year in which they cease working (the cessation year), and for the next five years.
This will last until they either have relevant earnings again or become a member of an occupational scheme throughout the tax year.
These are known as qualifying post cessation years. The cessation year and the five years immediately before it are called reference years. The maximum contribution in the five tax years after the one in which the individual ceases to have NRE can be based on NRE in any one of the reference years. This is the year in which they ceased to have NRE or any one of the five tax years immediately before that), as can be seen in Table 4.
The following example is taken from the Inland Revenue guidance notes. Ms Hall is 36 on 6 April 2001. She is self-employed and joins a personal/stakeholder pension in 2001/02 (year 1). She earns £50,000 in the first year of membership and makes contributions of £10,000 ' up to her limit of 20% of earnings. In each of the following five tax years, her earnings decrease, but she can still pay £10,000 each year as she nominated 2001/02 as her basis year. In March 2007, she stops working to care for a relative. She has no earnings for the following 10 years but is able to fund contributions from savings. Her cessation year is 2006/07.
Her five post cessation years are 2007/08 to 2011/12. She may continue to contribute in excess of £3,600, providing she has no relevant earnings and does not join an occupational pension scheme. Her 'reference years' are the six years preceding the first post cessation year ' in her case 2001/02 to 2006/07. If she wishes to nominate 2001/02 as her basis year, she may continue to pay £10,000 a year into the pension up to 2010/11 and £12,500 (as she is now 42) in 2011/12. From then on, she will have no NRE and will be limited to paying up to £3,600 a year.
There are a few final points to be aware of when dealing with cessation of earnings. The first tax year without earnings, the 'break year', must not be before 2001/02. If the individual had no net relevant earnings in 2000/01, then the new cessation of earnings facility cannot be used for the current period without earnings.
If earnings resume during the five-year cessation period, contributions can be based on the new earnings, or the previous earnings in any of the five tax years prior to the relevant tax year. Employer contributions can continue up to the end of the tax year in which the member left employment.
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