Retirement

In the case of a director approaching retirement, it may sometimes be necessary to maximise their earnings so as to secure them the best possible level of pension. Obviously, in this case a bonus is undoubtedly preferable to a dividend payment, as dividends do not rank as pensionable earnings.

It should also be borne in mind that employer pension contributions are not subject to tax or NI. There is usually little difficulty in justifying the level of personal pension contributions, provided they are not excessive.

Under the existing personal pension rules, the maximum contributions payable in any tax year are the higher of £3,600 (gross) and the amount payable by reference to the personal age and earnings related limits.

Pension premiums

% of Net Relevant Earnings (NRE) 2004/05
Age at the beginning of the tax year *personal pensions (including stakeholder) Retirement Annuities
35 or less 17.5 17.5
36 - 45 20 17.5
46 - 50 25 17.5
51 - 55 30 20
56 - 60 35 22.5
61 - 74 40 27.5
*Maximum contributions 2004/05: higher of
- £3,600 (gross)
- % of NRE capped at £102,000

One of the interesting rules introduced recently means that an individual can be locked into net relevant earnings (NRE) of a peak year by giving the pension provider evidence of the earnings of that year. This establishes the earnings that can be used as the basis for the contributions not only of that year but also the following five. See example below.

Example - an individual has peak earnings in year 1 and a lesser peak in year 3
Year Earnings £ 000 Year nominated Basis year £000 NRE
1 50 1 1 50
2 30 1 50
3 40 3 1 50
4 - 6 25 1 50
7 - 8 20 3 40


In simple terms, this means that higher remuneration could be taken in an earlier year and then followed by five years of minimal salary and large dividends so as to obtain the best of both worlds.

However, the pension rules will be changed substantially from April 2006 and so planning in this area will be subject to major revision at that time.