Work-arounds to new tax relief cap

As the treasury revealed that it has no plans to change the proposed tax relief restrictions on pension contributions for higher earning Contractors, we have discovered a work around for certain income brackets

For those Contractors that enjoy earnings of £150,000 per year or over, the news that there will be restrictions on the tax relief you can receive on pension contributions have been a blow.

Many thousands of Contractors have used the pensions simplication rules, introduced in 2006, to good effect as a means of significantly reducing their tax bills. Our own clients alone will have collectively saved tens of millions of pounds that would otherwise have gone to the Exchequer.

Unfortunately we've recently seen this simplification regime begin to unravel and despite widespread opposition to the proposal, the Treasury announced this month that they have no plans to withdraw the proposals and plan to carry on with the rules that will come into play in April 2011.

If you expect to receive an income (salary and dividends but also any rental and investment income etc) in excess of £150k pa in 09/10 or have enjoyed such earnings in the past 2 years, then instead of an annual pensions contribution allowance of £245kpa there is now a special annual allowance that applies which will cap what you and your company can invest on your behalf. We have looked at the impact for various earnings brackets and advise the future planning required -

Over £170k

You do fall foul of the new restrictions and the annual allowance is dramatically reduced to just £20k pa. Investments in excess of this level will still be possible but you personally will have to repay the equivalent of high rate tax relief on any pension contribution made by you or on your behalf. This reclaim of the 20% tax relief will be via your self assessment.

We would advise that you seriously consider setting in motion a regular investment for the new trading year to not only maximise the reduced tax break still available but hopefully also to safeguard the right to continue contributions should the rules change again.

The reason for this recommendation is as a result of the fact that when HMRC brought in the new £20kpa cap they specifically exempted from the new rules any pre-existing regular pension investment (made on at least a quarterly basis before 22nd April). We have existing clients investing in excess of £20k per month who followed our advice to 'drip feed' their contributions and to whom the new rules have had no impact whatsoever. It could be likely that any future restrictions could also exempt existing contribution levels.

Between £170k and £150k

If you are borderline in terms of breaching this income threshold (earning or having earned between £150k and £170kpa) then we have found a work around to the new rules. By salary/dividend sacrificing £20k of your income you then fall below the £150k threshold which then opens the gates to far more substantial investment.

This work-around only applies specifically to this income bracket as the £20k cap means that higher earners cannot exploit this quirk of the rules.

Similarly gift aid can be used to reduce the previous tax year's earnings below the £150k level. Under £150k

If you fall under the £150k earnings figure then the new cap does not apply and you should be free to invest as planned but we would advise that you seriously consider setting in motion a regular investment for the new trading year.

With the hole in the public finances growing ever wider there is real concern that further pension changes could be forced through in future budgets. Setting up a regular contribution now could potentially protect your ability to continue exploiting these tax breaks in the future.

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