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March 30, 2007 3:56 pm

Power up your pension – but don’t overdo it

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Those wishing to fast- track their retirement have been making the most of new annual allowances, which enable individuals to power up their pensions with large contributions.

Changes to pension laws last year gave bigger financial incentives for City high- flyers and other higher earners to enjoy tax relief of up to 40 per cent by piling cash into their Sipps.

Under the new “A-day” regime, individuals, up to the age of 75, can pay their gross salaries straight into their pension to a maximum of £215,000 per annum, rising to £225,000 in 2007/08.

Contributions can also be accepted from employees, employers, the self-employed, and (subject to a maximum of £3,600) those who have no relevant earnings.

There is scope under the rules to make unlimited contributions; however, payments are only tax efficient at or below the annual allowance. Tax relief is also limited by a Lifetime Allowance of £1.5m for the current tax year, rising to £1.6m in 2007/08 and £1.8m by 2010/11.

The perks of pension pumping as a financial planning tool are weighted towards higher rate taxpayers, who have the power to be able to claim extra tax relief on their savings at their marginal rate.

It is estimated that a higher rate taxpayer can, by grossing up basic and higher rate relief, achieve a £215,000 pension fund for a net outlay of only £129,000.

With an incentive such as this, financial advisers say it makes sense for higher-rate payers to consider pensions above other forms of saving.

“You either have £60 in a bank deposit or £100 in a pension,” says Paul Garwood, director of personal financial planning with Smith & Williamson. “If they double in value they become £120 and £200 or £96 and £140 after tax, which demonstrates the enormous benefits of tax relief on a pension.”

Perhaps unsurprisingly those with substantial funds for pension savings are being attracted towards Sipps, where an individual can have complete control over their retirement pot.

Once in the Sipp, the member can invest in a wide range of assets or asset classes, from commercial property and shares to unquoted hedge funds.

Charles Stanley is one Sipp administrator and stock-broker that is targeting sophisticated wealthy investors with strategies to safeguard large year-end bonuses.

The firm says it is possible under the rules to put more than that year’s allowance into a Sipp.

“By thinking in terms of HMRC ‘input periods’ rather than tax years, investors can put more than a single year’s allowance into their pension plans,” says Charles Stanley.

For example, the broker says an individual could add the next tax year’s maximum investable allowance (£225,000 in 2007/08) to this year’s allowance (£215,000) to invest a total of £440,000 before this tax year ends on April 5.

While a lucky few can sacrifice big bonuses to maximise tax perks fairly quickly, others are using different strategies to plump up their Sipps, including pension consolidation.

“We have seen quite a lot of transfers in from personal pensions and ex-occupational schemes,” says Simon Pimblett, head of research and development at the Route Group.

“We have also seen quite a number of ‘in specie’ transfers of shareholdings. And a fair number of people are choosing to encash non-pension investments and invest the proceeds into their Sipp.”

While maximising your Sipp allowance is tax efficient for higher-rate payers, operators say that investors should seek advice before making any big investment decisions, particularly when doubling up their contributions.

“That is absolutely crucial,” says Stanley. “Young people who will benefit from the compounded effect of their investments over the years might well reach the lifetime threshold before they retire.”

Sipp investors now need to be careful not to fall foul of annual allowance rules or lifetime limits.

“In the old [pre A-day] days we would ask a member to show their payslip to prove their earnings were sufficient for the contribution,” says Fergus Lyons, commercial director with AJ Bell. “But it is up to the member to manage this now through the self-assessment process. They could face a charge for exceeding their allowance if they are not careful.”

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