Pensions

Know your limits and make amends if you have fallen behind with pension payments, says Pam Atherton.

Whether you save for retirement via a pension scheme provided by your employer (final salary or money purchase) or privately through a personal pension, you will face contributions limits.

If you are a member of a company final-salary or money-purchase scheme, you can top up your pension in two ways.

Firstly, you can make additional voluntary contributions (AVCs), either to your employer's plan or to a Free Standing AVC scheme run by an insurance company.

Contribution limits

Your maximum contribution limit to your main company scheme and AVC, in aggregate, must not exceed 15% of your annual gross salary derived from your employer.

So if you contribute, say, 8% of your gross salary to the company scheme, you could save up to 7% in an AVC.

At retirement, AVCs have to be converted in their entirety into an annuity, which has made AVCs unpopular in recent years because of pitifully low annuity rates.

This will change with pension simplification which is due to take effect from 6 April 2006, when 25% of an AVC fund can be converted into tax free cash at retirement, and the balance converted into an annuity.

Stakeholder pension

As a member of a company scheme earning £30,000 pa or less (and not a controlling director), you can invest up to £3,600 pa into a stakeholder pension.

Stakeholder contributions can be paid with money from any source and will not count towards the 15% contribution limit to your company and AVC schemes.

Personal pensions

If you have any form of personal pension, such as a group personal pension, a self invested personal pension or a stakeholder, the top up rules are completely different.

Personal pension contribution limits

Age          % of net relevant earnings

Under 36     17.5
36-45        20.0
46-50        25.0
51-55        30.0
56-60        35.0
61-74        40.0

Earnings limit £102,000

Basis year

You can mop up unused tax relief from previous years using the so-called 'basis year' rules. These allow you to make personal pension contributions based on your best year's earnings in any of the last five tax years - even if you are currently earning nothing and are a non taxpayer.

For instance, a man aged 64 today, and who expects to earn £15,000 in the current tax year, but who had an income of £50,000 in the tax year 2000-2001 could nominate 2000-01 as his 'basis year' and could make maximum pension contributions in that year and the following five years up to 2005-06 based on his £50,000 earnings in 2000-01.

As a 64 year old, he can make a gross contribution of £20,000 (£50,000 x 40%), or £15,600 net of standard tax, or £12,000 if he is a higher rate taxpayer.

Tax relief

All personal pension contributions are made net of 22% standard rate tax automatically, even if you are a non taxpayer. Higher rate taxpayers can reclaim the extra 18% higher rate tax via their self assessment tax return, but only to the extent that you have paid higher rate tax in the year of payment.

Nick Bamford of Surrey based IFA firm, Informed Choice, warns "As tax relief is based on your tax position in the year of payment, be sure that you do not lose out by only getting basic rate relief on the contribution paid, but pay higher rate tax when the pension comes into payment".

100% allowance

The basis year rules will apply until 6 April 2006, when they will be swept away by a new simplified pension system.

This will introduce an annual contribution allowance for everyone of 100% of earnings up to £215,000 in 2006-07 (rising each year to £255,000 in 2010-11) and a lifetime limit on individual pension funds of £1.5 million (rising to £1.8 million in 2010-11).

In addition, non-taxpayers are able to pay £3,600 gross or £2,808 net of standard rate tax under both before and after 6 April 2006.