Tax relief on pension investment

Like the sound of slashing your tax bill while simultaneously providing for a comfortable retirement?

Like the sound of slashing your tax bill while simultaneously providing for a comfortable retirement?

If so, whether you're a PAYE worker or self-employed, you should give serious consideration to investing a lump sum in your pension before the end of this month.

In general, tax relief is given in the year the contribution is paid into the pension, but there is an exception to this rule. Top-ups made between January 1st and October 31st of this year can be treated as paid in 2006 if the individual elects for this option.

This means that a window of opportunity is still open for anyone who wishes to top up their pension, have it backdated to 2006 and potentially receive tax relief at 42 per cent (the top rate of income tax in 2006).

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When deciding how much cash to inject into their retirement fund, individuals should bear in mind that the maximum amount of tax relief available depends on their earnings and age. So for example, a 25-year-old employee can only contribute 15 per cent of their taxable income to their pension plan for tax relief purposes.

This rises to 20 per cent for people between the ages of 30 and 39 and 25 per cent for those in their 40s.

The age bands narrow thereafter in recognition of the importance of topping up pensions as much as possible as retirement approaches.

From 50 to 54, people are allowed to contribute 30 per cent of net relevant earnings, increasing to 35 per cent for those aged between 55 and 59.

Over the age of 60, the contribution limit rises to 40 per cent.

Self-employed workers weighing up whether or not to pump up their personal retirement savings account (PRSA) or retirement annuity contract (RAC) before the impending Halloween deadline should factor in the knock-on cash flow benefit that this could bring. By cutting their 2006 income tax bill, self-employed individuals can also reduce their preliminary tax payment for 2007.

This is because their 2006 tax liability can be used as a basis for calculating preliminary tax.

The October 31st deadline also applies to employees who are members of company pension schemes and who wish to maximise their pension relief and reduce their 2006 tax bill by making extra top-ups (known as additional voluntary contributions or AVCs) outside of payroll. The age-related contribution limits also apply in this situation.

"Employees more than ever . . . need to play an active role in ensuring they have an adequate pension fund built up," says James Skehan, head of pensions at New Ireland.

"With October 31st looming, there is no better time than now for an employee to review their situation and to see if they wish to take advantage of backdating an AVC payment against last year's tax bill."