Pension Planning - Defined Contribution

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Defined Contribution

Major changes to the way retirement savings can be made have been introduced since April 2001. One change is the introduction of stakeholder pension schemes. Another is the new 'DC regime'.

The DC regime is a single system for making payments to all the following `defined contribution' (DC) pension arrangements:

• Stakeholder schemes
• Personal pensions
• Old-style personal pensions called retirement annuity accounts
• Occupational money purchase schemes - but only those schemes, which opt into the new regime. You must work for the employer running the scheme to be eligible.

Limits on what you can pay

Under the new regime, you can pay up to £3,600 a year (before taking into account any tax relief in total into any of the above pensions, regardless of your earnings). Even if you have no earnings at all, you can still pay up to £3,600 in pension savings.

If you want to pay in more than £3,600 in a year, you can do this provided the contributions do not breach a limit based on your age and earnings. In fact, contributions do not have to be paid by you; you, your employer, a relative or anyone else can pay them. For example, if you are a woman off work caring for children, your husband or partner could pay into your pension scheme for you. A parent, say, can pay contributions for a child. If you are an employee who receives shares under an approved employee share scheme at work, you can transfer these shares into your pension scheme, provided you stay within the contribution limit. You can use up to 10% of the amount you contribute to pay premiums for life cover.

Any National Insurance rebates paid in because you are contracted out of the part of the state scheme do not count towards the limit. Any amount you pay for a `waiver of contribution' option does not qualify for tax relief and does not affect your contribution limit. This option is often available with plans where you contract to make regular payments, say monthly. The waiver pays your contributions for you if you lose your income because of illness or disability. Contributions paid under the waiver qualify for basic-rate tax relief in the normal way.

All contributions under the new DC regime are paid after deducting tax relief at the basic rate. The scheme provider then claims the relief back from the Inland Revenue and adds it to your scheme. You keep the relief you have deducted, even if your income is too low to pay that much tax. This means that, if you have no earnings or are on a low income, the government effectively adds a bonus to your pension savings.

If you are a higher-rate taxpayer, you can claim extra tax relief, which you receive through either the self-assessment system or PAYE. The ceiling contribution limit is £3,600.

If you want to contribute more than £3,600 in any year to the pensions in the DC regime, you can provided your total contributions come to no more than the limit shown in the table below. (These are the same percentage limits that apply to personal pensions in the period up to April 2001.)

The earnings on which your percentage contribution is based are your earnings for a basis tax year. You choose the basis year and are then deemed to have earnings at that level for the next five years, regardless of any change in your actual earnings.

If you want to change the basis year - for example, because your earnings have subsequently increased -you can. The basis-year system enables you to continue paying contributions in excess of the £3,600 limit for five years if your earnings stop. After five years, the maximum you could pay would drop to £3,600 a year.

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