Tax relief on pension contributions is under threat. It has not gone yet. But from 2011 the top 1% of the population with an income over £150,000 a year will get their tax relief reduced to the 20% allowed to people on basic rate tax. This change could be the thin end of a very fat wedge. Until now higher rate tax relief on pension contributions was a sacred cow that the Treasury would never sacrifice. But the need to borrow more than £170 billion this year and next, pushing the Government’s debt to more than £1.5 trillion by 2013, seems to have changed Treasury thinking. And now that the very richest are to lose this benefit, next on the list might be people with incomes above £43,875 who pay higher rate tax. Cutting their 40% tax relief down to 20% would save the Government three times the £3.1 billion a year it reckons to make by cutting tax relief for the richest. So if you are lucky enough to be among the one in eight taxpayers who pay 40% tax it may be a particularly good idea to boost your pension contributions now in case tax relief at that rate disappears in the future.

And the great majority who do not pay higher rate tax should also consider putting extra money into a pension. Especially if they are aged 49 to 54. At the moment you can take your pension benefits once you reach 50. From 6 April 2010 that age rises to 55. So anyone aged 50 to 54 should consider their options now or face a five year wait before they can act.

Now you may be thinking ‘retire at 50! Chance would be a fine thing!!" But the rules let you take your pension without giving up your job or retiring. And you can even use the pension you draw to pay into another pension. And that can be a useful way of maximising your pension for when you really need it later in life.

Some of you will have noticed that the tax relief on £800 is £200 and that £200/£800 is 25% whereas the basic rate of tax is 20%. The reason is this. You pay into your personal pension out of income that has already been taxed. To have £800 left after tax you will have earned £1000. Because the tax due on that £1000 x 20% is £200 leaving you with £800. It is this £200 tax that is now returned to your fund.

As a rule of thumb work out what you can afford to put in out of your net income and add 50%. By the time you have got the tax relief and taken the tax-free cash you will end up paying the amount you originally thought of. [For example, if you can afford £1000, add 50% and pay £1500 into your pension fund. Tax relief adds another £375 so your fund is now £1875. You can immediately take out a quarter of that tax-free which is £469. That leaves your fund at £1406 and the cost to you has been £1031.]

The arithmetic is even kinder for higher rate taxpayers. You can safely write a cheque for 2.3 times the amount you really want to pay into your pension out of your net income. If that is about £1000 you actually pay in £2300. Basic rate tax relief is added which boosts it by £575. You then take your benefits and the 25% tax free cash is £719. So it has cost £2,300 - £719 = £1581. And when you do your self-assessment form you reclaim higher rate tax relief of £575 which brings your actual outlay down to £1006. At the same time there is £2156 in your fund.

If you are aged 50 to 74 you can do this now. But if you are under 55 act before 6 April 2010 or you will have to wait up to five years.

The downside is that you have money in a pension fund and there are restrictions on what you can do with it. But they are much more lax than they used to be. The money can just stay there and grow – you can even pay more in if you want. If the fund does grow – with or without extra contributions from you – then you can take 25% of the growth as another tax-free lump sum at a later date. And you can decide when to convert the fund into a pension or draw an income from it right up to the age of 75 – and even then you do not have to buy a pension though the alternative of taking an income of about 80% of what you would get from an annuity is not terribly attractive.

Falling share prices have hit pension funds recently. As you approach retirement there is no time to wait for the market to rise again. So if you start a new pension late in life it is best to choose a cash fund. Make sure it really is a cash fund with no risky investments and low charges – around 0.5% a year. That way you get the advantage of the tax relief and none of the risk of losing it if shares fall in value.

Guaranteed annuities
If you began your pension more than about fifteen years ago you may get a nice surprise when you find out what your benefits are. Many of these older pension plans – especially retirement annuity contracts (also known as section 226 pensions) from before 1 July 1988 – have what are called guaranteed annuity rates or GARs. That means you are guaranteed the rate at which your pension pot is converted into a pension. Some GARs are 12% or more. In other words if you have £100,000 in your fund you will get 12% of that – £12,000 a year – as a pension for life. That is almost double the £7,000 a man might get at 65 for a £100,000 fund on the open market. So if you have a pension you started some years ago find out if it has a GAR. If it does ignore the usually very good advice to find the best deal on the open market. If you do you will lose your rights to the GARs. You will also lose your GAR if you move your pension fund to another provider. Also check the date you have to retire to get the GAR – some have restrictions. GARs can be inflexible in other ways. If you have health problems you may get a better open market deal. And a GAR may not provide for a widow or against inflation. So check carefully. But a GAR is usually best.