Still time to mop up

Tax breaks worth thousands of pounds vanish at the end of this month because new rules mean people will no longer be able to mop up unused pension tax relief from up to seven years ago. But if you have not done anything about it, all is not lost: there is still time to beat the deadline.

The rule change is one of the final pieces of the stakeholder pension jigsaw, and actually came into force last April. But a separate rule, which lets taxpayers treat a pension payment is if it were made last year, gave a further nine months' grace. Anyone wanting to use this unclaimed tax relief must have pension allowance left over from last year. The deadline is 31 January, the same day as the deadline for 2000-2001 tax returns.

Scooping up old tax allowances appeals to the self-employed, whose income varies from year to year. Ray Graham, 56, based in Powys, Wales, runs a business importing off-road cars. He is using the chance to mop up his unused pension contributions and the tax break means he is really taking the best advantage of the Internal Revenue's rules, and making the most of his money. The details of how Mr Graham can do it are in the case study on the right.

But anyone with a personal pension plan, or who earned, but had no pension arrangements, can go back and top up his or her contributions. The tax break does not apply to those in occupational pension schemes, nor to additional voluntary contributions (FSAVCs).

How it works

Ray Graham is using the chance to mop up his unused pension contributions because in the past few years, most of his capital has gone into the business. He is taking out a pension with Standard Life through Hargreaves Lansdown and, because he will be making a substantial contribution, charges will be less than 0.5 per cent.

Mr Graham, pictured left, is using last year's tax allowance to catch up on missed contributions, and is topping it up with this year's contribution. In all, this allows him to put £100,000 into his pension at a net cost of £60,000. Because he is over 50, he can take 25 per cent in cash now, so the effective cost is just £35,000.

"I hadn't been that bothered about pensions, and my business needed working capital," he says. "But these rules, and the advent of the stakeholder pension, have given me a wonderful opportunity to catch up just in time."

Using the break is not complicated, but it does mean a fair bit of paperwork. One problem is that the Inland Revenue rules state taxpayers have to start using up their allowances from the oldest relevant tax year, which could be as long ago as 1995.

"Most accountants can produce this information at a touch of a button," says Danny Cox, pensions development manager at Hargreaves Lansdown. "But problems can arise when a client doesn't have an accountant, or was employed and needs to prove how much was paid into a personal pension." If one year's figures are missing, completing the calculations in time could be impossible.

To prove earnings, a pay slip, P60 or self-employed people's accounts will be sufficient. You will also need details of personal pension or retirement annuity contract contributions. For taxpayers 35 or under, the maximum contribution is 17.5 per cent of earnings. This rises by stages to 40 per cent for those over 60.

The total contribution attracts tax relief at your top rate for 2000-2001. This applies even if you paid basic-rate tax only in some years. The total, including tax relief, cannot be more than your 2000-2001 tax year's income. Acting now also opens the door to low-cost stakeholder or stakeholder-friendly pension plans.

Stakeholder fees are capped at 1 per cent of the fund, and some providers, such as Norwich Union, Standard Life and Legal and General, charge even less. This is a bonus: charges on a pension bought in 1995 could be as high as 7 per cent.

In practical terms, most independent financial advisers should be able to process applications before 31 January. Hargreaves Lansdown will work out the calculations for £50, but refund this if you buy a pension through the firm. The forms are available online (www.hargreaveslansdown.co.uk).

Finding the money to make that final tax-blessed contribution could be a bigger barrier. Fortunately, under Inland Revenue rules, all pension contributions are paid net of basic rate income tax.

This means you have to hand over only £780 for every £1,000 of contribution. Higher-rate taxpayers reclaim the rest of the tax through their tax returns, and the Revenue can opt to do this by reducing next year's tax payments.

"The sums involved could be several times your salary, so we do find this is an option most used by people nearing retirement, or who have redundancy money," says Martin Thompson, pensions development manager at the independent adviser Sedgewick IFC. In extreme cases, he suggests, it could be worth borrowing money to beat the deadline.

If the bank balance is not up to it and the form-filling means you miss the deadline, disaster need not necessarily follow. The stakeholder pension rules allow other ways to make extra contributions.Perhaps the most important is the basis-year rule. This means taxpayers can choose any one of the past five years to determine their pay for pension purposes. Someone with fluctuating income, but money for a pension contribution, can pick the most lucrative year.

Under stakeholder rules, anyone can also pay £3,600 into a pension regardless of earnings. For couples where one partner does not work, this is a good way to add to their overall pension fund. Old-style retirement annuity contracts are not affected by the change.

Nor is shifting pension payments back to last year always the best choice. People with rising earnings, but who can only scoop up a few years' contributions, could lose if their tax rate this year is higher than last year's.

"The deciding factor has to be your tax situation," says Andy Agar, pensions marketing chief at Legal & General. "If your earnings last year are lower than this year, you will need financial advice."