Personal Pension schemes are plans, approved by the Inland Revenue, and run by insurance and pension companies, which are long term savings schemes, designed to provide for retirement. Because of the generous tax advantages, they have rules that must be adhered to in order to qualify for the tax concessions.
Eligibility And Qualifying Earnings
Anyone may contribute up to £3,600 per year gross (£2,808 net at current tax rates) to a Personal Pension Plan. If you want to contribute above this limit, you must have qualifying earnings to be able to put your money into one of these schemes. This means that your earnings must come from:
- self employment, or
- employment with an employer which does not have a pension scheme of its own, or
- furnished holiday letting income.
If you do not have earnings which qualify, the Inland Revenue can instruct the Pension company to repay to you any contributions you have paid.
Concurrency
An individual may pay contributions to a Personal Pension Plan as well as paying contributions to an occupational pension scheme at the same time. This is known as concurrency.
Contributions And Tax Relief
Contributions to a Personal Pension Plan are regulated, because the contributions benefit from tax relief.
Limits Of Contributions
The maximum limits of contributions to Personal Pension Plans are expressed as a percentage of the taxable income from the sources of income listed above in any tax year. The limits are as follows:
Note that the age is at the
start of the tax year. There is also an overall limit to the contributions which may be paid in any tax year. This limit is the relevant percentage according to the table above, on the ‘earnings cap’. The earnings cap is currently £105,600.
Basis Year
There are very generous rules allowing you to make contributions based on your best year’s earnings in any of the past five years. The best year’s earnings can be nominated as your ‘basis year’. This is also sometimes known as ‘benchmarking’. Note however that the earnings must be the ‘Net Relevant Earnings’ for the basis year – i.e. they cannot be earnings when you were a member of an occupational pension scheme. They must be the earnings which qualify you to contribute to a Personal Pension Scheme.
The rules are very generous because:
- The earnings are based on the year you nominate.
- The age used as the basis for the percentage of earnings is the age at the beginning of the year of payment of contribution.
- The earnings cap is based on the year of payment of the contribution.
Any contributions made in the basis year do not affect the maximum limit in the year of payment.
Tax Relief
All contributions are made to the pension provider net of the basic rate of income tax, presently 22%. Thus, if a person pays £780, they will have the extra £220 paid by the government, so that the total credited to their pension plan is £1,000. This tax relief is given to all individuals, whether or not they
are actually tax payers. In practice, this would only happen up to the £3,600 limit. Thus, if someone has no tax liability at all, they still only pay the net amount, and for every £78 paid, the government contributes the notional tax relief of £22.
If the person is a higher rate tax payer, the extra tax relief has to be claimed on the self assessment tax return each year. The additional tax (presently 18%) will then be refunded by way of a coding notice adjustment for directors and employees, or by the self-assessed tax paid by self-employed people. It can alternatively be claimed by completing an Inland Revenue form PP120.
You may make a special election to carry back contributions paid in a tax year to the previous tax year, as long as the limits of contributions in the previous tax year are not exceeded. Making this special election is beneficial if the rate of tax paid in the previous year was higher than the current year – for example, by paying the higher rate of tax. This election is made by completing Inland Revenue form PP43.