Pep up your pension - before it's too late

Amid all the fuss about the forthcoming Stakeholder pension, the removal of an attractive tax break for those saving for retirement through a personal pension has been largely ignored.

Amid all the fuss about the forthcoming Stakeholder pension, the removal of an attractive tax break for those saving for retirement through a personal pension has been largely ignored.

This tax break goes by the less than catchy name of "carry forward" relief. Its abolition on 6 April 2001, the very day that Stakeholder comes into being, could potentially cost the self-employed, contract workers and those who have left it late to save for their retirement thousands of pounds in lost tax relief. But act before that deadline, and you could give your pension fund a huge boost with some valuable tax relief.

Personal pensions are a highly tax-efficient way to save for your retirement. The Inland Revenue grants tax relief on your contributions, worth 22 per cent for basic-rate taxpayers, 40 per cent for higher-rate taxpayers. This means a £1,000 contribution to your pension plan costs £780 if you pay basic rate tax, or just £600 if you pay the top rate.

There are set limits on the amount you can contribute to a plan each year. You can pay 17.5 per cent of net relevant earnings up to age 35, which rises steadily to a maximum 40 per cent at age 61 and over, subject to an earnings cap which also rises as you get older, to a current maximum of £91,800.

The charm of carry forward forward relief is that if you have failed to use all your eligible tax relief during the previous six financial years, you can roll it all up and claim it in the current tax year -- although you cannot invest more your total annual salary.

Mark Rowlands, pensions expert with financial advisers Hargreaves Lansdown, says the scrapping of carry forward represents "a substantial loss for a small section of the population". The self-employed could suffer more than most. "They often have fluctuating earnings, and find it difficult to make regular pension contributions. Carry forward allows them to mop up previously unused tax relief when they have had a particularly good year financially, and catch up with their pension planning."

Other categories of saver will also lose out. "Carry forward is useful for those returning to the workplace after a couple of years off, for example. Similarly those who have only started making pension provision can also use it to play catch-up."

Mr Rowlands says that many people only wake up to the need to save for their pension as retirement approaches. "Many people in their forties have worked for 20 years without bothering to save for a pension, and need to build up a big fund in a short time. Carry forward has been able to help them. These people should act fast if they want to use the provision to boost their retirement fund."

Working out how much you can make in carry forward contributions can be complex, and you may need to seek advice from a financial adviser or your accountant. When using a financial adviser, check carefully how much you will be expected to pay either in commission, or in fees, before going ahead. "Many financial advisers now run computer packages to do the calculations, which help keep a lid on the cost of setting up a scheme. Set-up charges could cost you between 5 per cent and 6 per cent in commission, but some advisers will cut this to between 1 per cent and 2.5 per cent, so check before you make your choice," Rowlands says.

Company employees with the two main types of occupational pension, final salary or money-purchase schemes, cannot use carry forward rules. They can use additional voluntary contributions (AVCs) to top up their plan.

However, members of an employer's group personal pension scheme can use carry forward. "You can use it to top up your employer's group personal pension scheme. You don't have to tell your employer, simply make the arrangements through a financial adviser or accountant," he says. Carry forward is often mentioned in the same breath as a similarly-named pension tax break, carry back relief. This allows pension savers to make a personal pension contribution this financial year, but have it counted for tax purposes as if it had been made the previous year. This allows those with fluctuating incomes to claim a higher rate of tax relief than their current earnings would dictate. If they are in sufficient income to be a basic rate taxpayer this year, but last year earned enough to pay higher-rate income tax, they can use carry back to claim the 40 per cent rate of tax relief, basing it on that previous year's salary. Unlike carry forward, this will continue unchanged after 6 April.

Jon Briggs, associate director with Chartwell Investment Management, says because carry back is set to continue, a loophole remains for those who miss the 6 April 2001 deadline to mop several years' unused tax relief.

"If you miss this year's carry forward deadline, clever use of this rule gives you one last opportunity to make good that unused tax relief. Putting it simply, you can carry back for one year, then carry forward from the next six years."

Theoretically, this gives you until 31 January 2002 to claim your unused tax relief. But Tom McPhail, pensions development manager at financial advisers Torquil Clark, warns that this can be a tricky operation. "I have several clients who want to use carry forward this year. If we fail to beat the April deadline it will be complex to claim this unused relief using carry back rules."

Scrapping of carry forward is part of the Government drive to simplify personal pensions under Stakeholder. The new scheme has tax breaks of its own, allowing savers to invest up to £3,600 each financial year in a personal pension and receive tax relief on the contributions. Even those with no earnings can receive basic-rate tax relief on the contributions. Pensions may be opened on behalf of children, giving higher earners even greater opportunities to maximise their tax-efficient saving.

"Scrapping carry forward is part of a drive to persuade people to stick money in their pension every year, by encouraging a use it or lose it mentality. Allowing people to claim unused tax relief is thought to go against this," says Mr McPhail.

"The drawback is that it eliminates the scope for people who come into a lump sum periodically to use that to boost their pension."

Carry forward will continue for one diminishing pool of pension savers, those with old-style retirement annuity pensions, which were replaced by personal pensions in 1988. "This may be useful for them, but is the type of ongoing quirk that makes pensions confusing for most people to understand," says Mr McPhail.

For further information contact: Hargreaves Lansdown 0117 900 9000 or Torquil Clark 0800 056 1836.