Limit on pension contributions qualifying for relief

Limit on pension contributions qualifying for...

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Hi all - I am dealing with a client who made a personal AVC of £64K to his employer pension scheme in 2009-10 during which year his earnings totalled £43K.  The contribution is within his lifetime limit and he has never had earnings in excess of £130K in a year.

My understanding was that he is perfectly entitled to make this contribution, but that the tax relief is limited to that amount of the gross contribution which equals his earnings. This seems to be supported by Simons Taxes at E7.506.

Someone has since told me that the limit to earnings in the year does not apply if the contribution is in the year of retirement and the pension vests immediately (which conditions are satisfied in this case).  Not sure where he got that from but I can't see it corroborated.  Is he right?

A second but related problem is that he also made some charitable contributions under gift aid in the year.  When I put all this into our tax return software it does not cause there to be any clawback of the tax relief at source on the gift aid contributions, despite that having deducted the pension contribution from earnings he is left with no STI out of which to make a taxed gift aid payment.  Is my software treating this correctly?

Thanks for any insight.

With kind regards

Clint Westwood.

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By andymeeson
20th Aug 2010 17:01

Pensions problems etc

Your understanding is correct. The availability of tax relief is limited to gross contributions equal to 100% of the individuals' relevant UK earnings for the tax year [FA 2004 s.190].

This is the case even if those earnings exceed the "annual allowance" [FA 2004 s.228]. This "allowance" (£245,000 for the tax year 2009-2010) is the threshold above which tax relief is clawed back by the "annual allowance charge" [FA 2004 s.227].

The allowance only relates to "tax-relieved" contributions by the individual, together with all employer contributions. It also applies to Defined Benefit accrual for the year - measured as the increase in the individual's pension rights* over the year.

It excludes [s.229(3)] contributions or accrual in a pension scheme where the member vests all his rights (which is what your informant was talking about).

Because your client's AVC was above his earned income, only £43k were "tax-relieved". Assuming his accrual within the scheme was valued at less than £202k, then he is within the annual allowance anyway, so the fact of being in the year of vesting is essentially irrelevant.

* 10 x the pension (before any commutation into a lump sum) + any lump sum entitlement which does not require commutation.

I think the software may be right. Higher rate relief for pension contributions is obtained by extending the basic rate band [FA 2004 s.192(4)], not by reducing STI**. Higher rate relief for the gift aid is also given by extending the basic rate band [ITA 2007 s.414]. In both cases, the basic rate relief is taken at source, and so the contribution/gift does not feature as a deduction in calculating the individual's tax liability.

The only restriction on gift aid relief is at ITA s.423, which ensures that the tax relief given for gifts does not exceed the individual's tax charged for the year in accordance with s.425 (or, if that isn't possible, exceeds it by as little as is possible), which it does by clawing back personal and age allowances and trade union subs. There isn't a provision to claw back the relief given at source.

Assuming there remains sufficient tax to frank the gift aid relief, there will therefore be no effect, even though the pension contribution is equal to the earnings.

** Confusingly, you do reduce STI by the gross pension contribution for the purposes of calculating income for age allowance clawbacks.

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