Investments Crisis – where are we now?

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The 2020 share pricesmarket correction was coming with or without Covid-19, but the scale of the fall in investments values, plus the hit to world-wide and domestic supply chains and trade wasn’t anticipated. Six weeks ago, I sent all my clients an illustrated email whilst the markets were well and truly crashing around our ears. My message was clear: Hold fast! At time of writing now, the markets have recovered a good part of their late Feb/early March falls.

However, I am suspicious of the recovery to date. It seems premature. If one looks at the economic damage that lock-down has caused here and around the world, surely investments portfolio recovery will take at least a year or two.

So, what do you do? If you cashed-in during or after the crash, perhaps expecting worse to come, you may be trying to time your re-entry to the market. My warning to clients was that that is like trying to catch a sharp knife knocked off the counter-top: unless your timing is uncanny you will probably end-up worse off.

Unless your circumstances have suddenly changed, I think the sensible approach is keep your investments in more or less what you had before the crash for the time being. By all means move gradually towards a different long-term portfolio over time if you feel yours was unbalanced or ill-equipped to deal with the last crash, but don’t try and do it all at once.

If you have cash to invest, you might well consider doing some limited buying right now – some call it tranching, or phasing-in – to a target portfolio.

My advice to my clients remains to remain calm, try to ignore markets news and we will see the recovery in due course.

The views held here are my personal views and should not be interpreted as financial advice. I can only advise you after a thorough discussion as to your personal financial position, objectives and risk assessment.

EXPLAINING HOW ANNUAL ALLOWANCE AND EARNINGS LIMITS INTERACT- Source – Old Mutual Wealth

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When looking to make a contribution into a pension an individual must consider annual allowance & carry forward, and tax relief limitations relating to earnings.

The annual allowance may limit contributions made each tax year but carry forward can be used to contribute more. Both employer and personal contributions count towards the annual allowance.

Personal contributions can be limited by relevant UK earnings but employer contributions are not.

Employers may be able to reduce their tax bill by making a pension contribution but need to be careful they don’t put in too much, otherwise they will cause a tax charge for their employee.

It is important to understand that the annual allowance, personal contributions and employer contributions all have separate rules but also impact on each other. Understanding these rules will allow you to maximise contributions and avoid finding out later a tax charge applies.

The annual allowance can limit contributions made in the tax year

The standard annual allowance this year is £40,000. The individual’s annual allowance may be lower if they are a high earner or have triggered the money purchase annual allowance.

All contributions, no matter who pays them, count toward the annual allowance limit.

If contributions are made above the annual allowance, this may lead to a tax charge.

Carry forward can be added to the annual allowance

Unused annual allowance from the three previous tax years can be added (carried forward) to the current tax year’s annual allowance.

An individual can only carry forward from a year they were a member of a registered pension scheme for at least part of that year.

If they have triggered the money purchase annual allowance, carry forward is not available for contributions into money purchase schemes,

Tax relief on personal contributions are limited by relevant UK earnings

Individuals are entitled to tax relief at marginal rate on £3600 or up to 100% of relevant UK earnings for this tax year. For most people, this will be their salary. Income from dividends and rental income are not classed as relevant UK earnings.

Most personal pension schemes operate relief at source. This means basic tax relief is added by the pension scheme whilst additional tax relief is claimed via self-assessment. Because tax relief is limited and these schemes give tax relief up front, they will likely only accept contributions up to the individual’s relevant UK earnings.

It is possible to make a gross personal pension contribution above a person’s relevant UK earnings but it may be hard to find a provider willing to accept this.

All personal contributions made will count towards an individual’s annual allowance and carry forward.

Many people confuse unused annual allowance and unused earnings when looking at carry forward. It is only unused annual allowance that is carried forward. Unused earnings from previous years are not carried forward.

Employer contributions are not limited by relevant UK earnings

Employer contributions do not receive tax relief in the pension. As no tax relief is given, the employer contribution is not limited to the employee’s earnings like personal contributions.

However, if the employer pays in more than its employee’s annual allowance and carry forward, the employer will cause a tax charge for the employee. This is because all employer contributions will count towards annual allowance and carry forward.

An employer may be able to reduce the company’s tax bill by making a pension contribution but need to be careful they don’t put in too much

Many employers will want to offset the money they have paid as an employee pension contribution against their company tax bill. A pension contribution can be classed as a business expense. Whether this expense can reduce the company’s tax bill will depend on if the expense is wholly and exclusively for the purpose of the business. An accountant is the best person to assess the business expense.

Whilst an accountant might tell an employer they can justify a certain amount of pension contribution, the amount contributed might cause a tax charge. Remember annual allowance and carry forward include all types of contributions.

The annual allowance, personal contributions and employer contributions all have separate rules but also impact on each other

When deciding on the level of contribution to make an individual will need to consider how these rules and limits interact.

Whilst that individual may have available capital and annual allowance they may not have the earnings to make a personal contribution.

Alternatively whilst they have the earnings, they may not have available annual allowance and carry forward.

An employer may wish to make a pension contribution but not benefit by doing so if the expense is not justified.

It is important to look at how each contribution type is limited and then consider annual allowance and carry forward at the same time. If not, the individual may end up with a tax bill, the employer may not get the tax benefit they thought they would or the pension may have more tax relief within it than it should do.

A simple way to determine what contribution to make would be:

 

  • Determine what the individuals annual allowance is
  • Determine how much carry forward is available from the previous 3 tax years if applicable
  • Add the carry forward figure to this years remaining annual allowance
  • Determine how much has been paid for or will be paid for by all parties in this tax year
  • Decide who will be paying the contribution
  • If it is the employer, determine how much the employer can contribute without an annual allowance tax charge. The employer will determine if they can claim this as an expense
  • If it is a personal contribution, look at this year’s relevant UK earnings.
  • If the relevant UK earnings are higher than the remaining annual allowance and carry forward, the individual will know how much can be contributed
  • Where a contribution receives tax relief,  the maximum contribution will be equal to the relevant UK earnings if they are lower than the remaining annual allowance and carry forward

Examples

Below are some examples that should help bring the rules to life. The assumption for the below examples are that the standard annual allowance applies and the salary is the total relevant UK earnings.

Case 1) Mr A has a salary of £30,000. He is a deferred member of a registered pension scheme opened 10 years ago. He has not made any contributions for the last 5 years. How much can he put in the pension as a personal contribution with tax relief?

Mr A has this year’s annual allowance. He also has the previous 3 tax year’s annual allowance available as he was a member of a registered pension scheme in those years. This means the most that can go into the pension with no tax charge is £160,000 (£40,000 for this year and £40,000 carried forward from each of the previous 3 years).

Mr A only has a salary of £30,000 so regardless of the annual allowance available, he can only make a gross contribution of £30,000. If paying into a scheme that offers relief at source he will pay £24,000 and the pension scheme will add the rest.

This is because a personal contribution is limited to 100% of relevant UK earnings. Making a gross contribution of more than £30,000 will mean Mr A has received more tax relief than he is entitled to.

An employer could pay a contribution to make up the difference.

If Mr A puts more than his earnings into the pension the pension will contain more tax relief than is allowed. This will need to be rectified.

But what about the fact that Mr A earnt £30,000 each year for the last 3 tax years?

Carry forward does not enable unused salary from previous years to be carried forward to make a higher contribution than this year’s relevant UK earnings. You can never make a personal contribution with tax relief in the tax year that is larger than the relevant UK earnings for the tax year.

Case 2) Mr B has a salary of £80,000. He joined a registered pension scheme for the first time last year by paying in £30,000. How much can he put in the pension as a personal contribution with tax relief?

Mr B has this year’s annual allowance and can carry forward unused annual allowance from last year. As he was not a member before then, he cannot carry forward from other years.

This means the most that can go into the pension with no tax charge is £50,000 (£40,000 for this year and £10,000 carried forward from last year).

So in this scenario, even though Mr B has earnings of £80,000 he is limited to £50,000.

Case 3) Mr C has a salary of £70,000. He is a deferred member of a registered pension scheme opened 7 years ago. He has not made any contributions for the last 5 years. How much can his employer pay into his pension?

Mr A has this year’s annual allowance and the previous 3 tax year’s annual allowance available.

This means the most that can go into the pension with no tax charge is £160,000 ( £40,000 for this year and £120,000 carried forward).

Mr C’s earnings are irrelevant as he is not making a personal contribution. The employer can make a contribution of £160,000 gross.

Does that now mean the company can claim £160,000 as an expense that is offset against the company’s tax bill?

Just because a pension contribution won’t cause a tax charge for Mr C does not mean it can automatically be used to offset a company’s tax bill.

Just like any other expense like a company car or business lunch, it needs to be wholly and exclusively for the purpose of the business to be offset against the company’s tax bill. A company accountant will normally give guidance to an employer about how much it could claim as a business expense.

Annual Allowance and Carry forward
Personal Contributions count
towards annual allowance		 Employer Contributions count
towards annual allowance
Tax relief Limited to 100% of relevant
UK earnings in this tax year		 No limit on what is paid in pension
but may be a limit on how much can
be offset against company tax bill.


The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth’s interpretation of the relevant law and is correct at the date shown on the title page. While we believe this interpretation to be correct, we cannot guarantee it. Old Mutual Wealth cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

Does it make sense to gift surplus pension income?

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Pension freedom changed the dynamics of estate planning, with many individuals now gifting or spending assets which are part of the estate before touching their pension pot which remains IHT free. So does it make sense to gift surplus pension income? Gifting surplus pension income using the ‘normal expenditure out of income’ IHT exemption might seem a pointless exercise. After all, why give away something which isn’t in your estate in the first place?

But if pension withdrawals can be taken tax free (or at least at a lower tax rate than the beneficiary may pay on any inherited pension) there may still be a strong motivation to do so as part of an effective estate planning strategy.

There is no statutory limit on what can be given away and successful claims on regular gifts are immediately outside the estate. Combined with the flexibility offered by pension freedom, this can be remarkably efficient.

Estate planning with pension income

Many clients don’t start thinking about estate planning until after they have ceased working. The first priority must, of course, be ensuring their own income security in old age. But once this is done, should thoughts turn to gifting? Even with a fall in income in retirement, some clients may still have more coming in than they need.

Fixed incomes

Income from annuities or DB pensions can’t be adjusted, so any excess may end up simply being accumulated in the estate and could be subject to IHT on death. Even if it’s subsequently given away as a lump sum it would take seven years to be outside the estate.

However, if that surplus income is given away on a regular basis and the exemption claimed it is immediately outside the estate and offers an opportunity to pass on pension wealth tax efficiently.

This is perhaps an easier decision to make for these clients as the question is simply about what to do with their surplus income, and not whether to take more income from a flexible pension, unless they also have one of these.

Flexible incomes

Those in drawdown have greater freedom to pass on their accumulated pension savings. Any unused funds on death are available as either a lump sum or as inherited drawdown.

The remaining pension funds are typically free of IHT, so there’s unlikely to be an IHT advantage in taking more drawdown income than is needed. But there could be other motivations for doing so.

On a practical level, beneficiaries may need the money now rather than after the client has died. Or the client may simply wish to see their loved ones enjoy the money.

There could also be an income tax benefit. If the client dies after 75, any undrawn tax free cash entitlement will be lost. So what could have been taken tax free before their death would become taxable in the beneficiary’s hands.

However, if surplus income can be generated by making withdrawals which are tax free (or at a lower tax rate than the beneficiary is likely to pay) then there may be good reason to do so.

This takes us to a critical question.
What counts as  ‘income’ from a flexible pension? Flexi-access drawdown, (where there are no limits on what can be taken and withdrawals can be taken as combination of tax free cash and taxable income), gives significant scope to take withdrawals tax efficiently.

When it comes to gifting those withdrawals, the IHT rules also help here. The ‘normal expenditure out of income’ exemption doesn’t use the income definition used for income tax purposes. As income is not defined in the IHT Act, it follows normal accountancy practice to determine what is income.

HMRC have confirmed to us that regular withdrawals from flexible pensions, irrespective of the levels withdrawn and whether taken as tax free cash or taxable income, always count as income for the purpose of the IHT exemption. This creates an opportunity for at least 25% of the pension fund to be taken and gifted both income tax and IHT free.

Other conditions

But it is important to remember that the gifts still have to satisfy two additional conditions.

Firstly, the gifts have to be part of normal expenditure. Taking the full 25% tax free cash entitlement and giving it away is a one-off gift. The exemption clearly will not apply and the gift will be a potentially exempt transfer. There has to be an established pattern of gifting. Spreading the gifting of tax free cash over a number of years using a phasing strategy, so that all the tax free cash is taken by the client’s 75th birthday, is a better option.

The second condition is that the gifts should leave the client with sufficient income to maintain their usual standard of living. Any pension withdrawals needed to maintain this standard will not be ‘surplus’. Similarly, the amount of the gift which qualifies for the exemption may be limited if the client has to draw on other capital assets, such ISAs, bonds or OEICs, to supplement their lifestyle.

There is an obvious estate planning advantage to making gifts of assets which form part of the estate before giving away pension funds which do not. So capital gifting may take precedence over income gifts unless other savings have already been exhausted.

Record keeping

Last but not least, it is good practice for anyone who intends using the exemption to keep not only details of the gifts made but also their income and expenditure. This can be captured on the IHT403 form. Ultimately it will be down to the executors to make the claim. And it can be extremely difficult to collate this information post death.

Source: Standard Life technical consulting –
Information correct at 11/12/18

Income Tax Traps – there’s still time to avoid them

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I’ve been busy lately helping clients with strategies to save income tax where they e.g. earn over £100,000, or they are (or might be) subject to the tapered annual allowance for annual pension contributions (causing tax penalties next year). Or they simply wish to look at carry forward for pension contributions but aren’t sure how to proceed. These areas are interlinked. UK income tax monopoly

In the first case, you should be aware that as soon as your income exceeds £100,000, you begin to lose your personal allowance by £1 for every £2 your income exceeds it. This causes an effective income tax rate of 60% for earnings caught between £100,000 and £123,000!

In the second case, those people whose total gross income plus employer pension contributions exceeds £150,000 (“adjusted income”) are likely to have see their combined employer/employee pension contribution restricted – the tapered contributions allowance, with consequent tax penalties. This is a tricky area and many people were not ready for it last year!

But there are some simple ways of mitigating or even eliminating the tax charges which arise, using personal contributions into pension, often via unused pension allowances from the previous three tax years.

I have covered these areas in past blogs, and the links are:

You might also look at the current blog on tax year end opportunities which also sets these out and links to the older blog.

 

Her’es an example of tax savings that can be made:

In 2017-18, Phil earns a salary of £95,000 excluding bonus, and has taxable P11d benefits of £2,000. His employer pays pension contributions of £18,000 and Phil contributes £18,000 (gross) under the net pay method. He had no bonus last year but this year has a bonus about to be paid of £50,000.

Before taking steps:

  • Phil’s taxable income is £129,000. He will lose all of his personal allowance, and inter alia will effectively pay income tax at 60% on the band of earnings between £100,000 and £123,000.
  • Phil’s “threshold income” for pension annual allowance purposes is £129,000. He therefore exceeds the £110,000 threshold, and the tapered annual allowance will apply.
  • Phil’s “adjusted income” for pension annual allowance purposes is £165,000, which means he stands to lose £7,500 of his annual pension contributions allowance, reducing it to £32,500 (i.e. below the contributions already made!).

Solution:

Phil makes a personal lump sum contribution of £23,200. This is grossed up by tax relief at source of £5,800, so £29,000 is paid into his pension.

  • It reduces Phil’s taxable income to £100,000, saving £16,200 in tax (an effective rate of 55.9%!).
  • The lump sum pension contribution also reduces his threshold income below the threshold for tapered annual allowance (£110,000), so his annual pensions contributions allowance is not reduced and the full £40,000 allowance applies in 2017-18.
  • His total pension contributions exceed £40,000 (£18,000 + £18,000 + £29,000 = £65,000), but Phil is allowed to utilise carry forward allowance (unused annual allowance contributions) from 2014-15, 2015-16 and 2016-17 in order to cover the excess £25,000 contributed.

I agree that the foregoing isn’t the easiest to follow, so why not get advice? If you think you are affected and want to know what steps are available to you to avoid paying any more tax than you have to, I will be happy (subject to availability) to talk you through this area of tax planning free of charge by telephone. Just give me a call on 0345 013 6525 and if I can’t deal with it there and then we’ll schedule a time.

Best wishes

Tony Devine

 

Tax Year End Checklist – Our Top 10 Tax Year End Opportunities

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The tax year end is a good time to take stock and look at your tax position before the tax year closes. There are opportunities available to many, and in some cases significant tax savings can be achieved.

Checklist of our top 10 tax year end opportunities

your checklist for tax year end

(Source: Standard Life Technical 2018 – slightly edited)

2017/18 has been a relatively steady year for tax and pension planning. There were no surprises in the Budget, meaning you can continue to benefit from the existing range of tax reliefs and allowances to help save for the future.

This is good news and makes this tax year end very much business as usual. It’s simply a case of reviewing the year to date and identifying where there is still scope to save by maximising unused reliefs and allowances, or even how scope can be created.

The core elements of tax year end planning remain the same:

  • Make full use of available tax advantaged savings, such as pensions and ISAs
  • Ensure tax allowances are fully utilised and opportunities to extract savings tax efficiently aren’t wasted
  • For families, don’t ignore the respective tax rates and unused allowances of both partners.

We’ve created a checklist of our top 10 tax year end opportunities to explore with your clients, together with the key information required to make these a reality.

1. Pension saving at highest rate of relief

  • Successive Chancellors have decided against cutting the rate of tax relief on pension savings for individuals. But with the spotlight constantly falling on pension saving incentives at each Budget, relief at the highest rates may not be around forever.
  • Additional and higher rate taxpayers may wish to contribute an amount to maximise tax relief at 45%, 40% or even 60% (where personal allowance is reinstated) while they have the opportunity. Carry forward can allow contributions in excess of the current annual allowance. For couples, consider maximising tax relief at higher rates for both, before paying in an amount that will only secure basic rate relief.
Key information

  • Total taxable income to current tax year end.
  • Relevant UK Earnings e.g. earnings from employment or trade only.
  • Pension annual allowance available from current year and previous 3 years.


2. Keep the pensions annual allowance for high earners

  • Some high income individuals will face a cut in the amount of tax-efficient pension saving they can enjoy this tax year. The standard £40,000 AA will be reduced by £1 for every £2 of ‘income’ clients have over £150,000 in a tax year, until their allowance drops to £10,000.
  • But it’s possible that some people may be able to reinstate their full £40,000 allowance by making use of carry forward. The tapering of the annual allowance won’t normally apply if income less personal contributions is £110,000 or less. A large personal contribution using unused allowance from the previous 3 tax years can bring income below £110,000 and restore the full £40,000 allowance for 2017/18 provided it is made before tax year end. And some of it may attract 60% tax relief too.
  • Remember that high earners may also have a reduced annual allowance from 2016/17.
  • For further detail see Higher Earners are you affected by the new tapered (restricted) tax relief on pension contributions? Read on for Possible Solutions
Key information

  • Adjusted Income for this year and last (broadly total income plus employer contributions).
  • Threshold Income for this year and last (broadly total income less individual contributions).
  • Pension annual allowance available from current year and previous 3 years.


3. Boost SIPP funds now before accessing flexibility

  • Anyone looking to take advantage of income flexibility for the first time may want to consider boosting their fund before April 5th tax year end, potentially sweeping up the full £40,000 from this year plus any unused allowance carried forward from the last three years.
  • The Money Purchase Annual Allowance (MPAA) will mean the opportunity to continue funding will be restricted. The MPAA is now £4,000 a year since April 2017. If a client is subject to the MPAA, they cannot use carry forward.
  • Clients requiring money from their pension can avoid the MPAA and retain the full £40,000 allowance if they only take their tax free cash.
Key information


4. Sacrifice bonus for an employer pension contribution

  • March and April is typically the time of year when many companies pay annual bonuses. Sacrificing a bonus for an employer pension contribution before the tax year end can bring several positive outcomes.
  • The employer and employee NI savings made could be used to boost pension funding, giving more in the pension pot for every £1 lost from take-home pay.
Key information

  • Size of bonus (if yet to be paid and before tax year end).
  • Pension annual allowance available from current year and previous 3 years.
  • Employer willingness to pay in NI savings.
  • Provisions for changing contract of employment.


5. Dividend changes and business owners

  • Many directors of small and medium sized companies may be facing an increased tax bill following changes to the taxation of dividends. This could be amplified next year when the tax free dividend allowance drops from £5,000 to just £2,000. A pension contribution could be the best way of paying themselves and cutting their overall tax bill. (further details at MPAA and Dividend Allowances cuts delayed as Finance Bill trimmed )
  • And, of course, if the director is over 55 they now have full unrestricted access to their pension savings.
  • There’s no NI payable on either dividends or pension contributions. Dividends are paid from profits after corporation tax and will also be taxable in the director’s hands. By making an employer pension contribution, tax and NI savings can boost a director’s pension fund.
  • Employer contributions made in the current financial year will get relief at 19% (this is also the planned rate for the next 2 years) but the rate is set to drop to 17% in 2020. So those business owners who cannot fund a pension every year, may wish to pay sooner than later if they have the profits and the cash available.
Key information


6. Maximise ISA subscription limits

  • ISAs offer savers valuable protection from income tax and CGT, and for those who hold all their savings in this wrapper, it’s possible to avoid the chore of completing self-assessment returns.
  • The allowance is given on a use it or lose it basis, and the period leading to the tax year end, often referred to as ‘ISA season’, is the last chance to top up. Savings delayed until after 6 April 2018 will count against next year’s allowance.

Key information 

  • Remaining annual  ISA allowance.


7. Recover personal allowances and child benefit

  • Pension contributions reduce an individual’s taxable income. In turn, this can have a positive effect on both the personal allowance and child benefit for higher earners resulting in a lower tax bill.
  • An individual pension contribution that that reduces income to below £100,000 will mean the tax payer will be entitled to the full tax free personal allowance. The effective rate of tax relief on the contribution could be as much as 60%.
  • Child Benefit is eroded by a tax charge if the highest earning individual in the household has income of more than £50,000, and is cancelled altogether once their income exceeds £60,000. A pension contribution will reduce income and reverse the tax charge, wiping it out altogether once income falls below £50,000.
Key information

  • Adjusted net income (broadly total income less individual pension contributions).
  • Relevant UK earnings.
  • Pension annual allowance available from current year and previous 3 years.


8. Take investment profit using CGT annual allowance

  • Clients looking to supplement their income tax efficiently could withdraw funds from an investment portfolio and keep the gains within their annual exemption.
  • Even if an income isn’t needed, taking profits annually within the CGT allowance and re-investing the proceeds means that there will be less tax to pay when clients ultimately need to access these funds for their actual spending needs.
  • Proceeds cannot be re-invested in the same mutual funds for at least 30 days otherwise the expected ‘gain’ will not materialise. But they could be re-invested in a similar fund or through their pension or ISA . Alternatively the proceeds could be immediately re-invested in the same investments but in the name of the client’s partner.
  • If there is tax to pay on gains at the higher 20% rate, a pension contribution could be enough to reduce this rate to the basic rate of 10%.
Key information

  • Sale proceeds and cost pool for mutual funds/shares.
  • Income re-invested into mutual funds (for income and accumulation units/shares).
  • Details of any share re-organisations.
  • Gains/losses on other assets sold e.g. second homes.
  • Losses carried forward from previous years.


9. Cash in bonds to use up PA/starting rate band/ PSA and basic rate band

  • If your client has any unused allowances that can be used against savings income, such as Personal Allowance, Starting Rate Band or the Personal Savings Allowance, now could be an ideal opportunity to cash in offshore bonds, as gains can be offset against all of these.
  • For those that have no other income at all in a tax year, gains of up to £17,500 can be taken tax free.
  • If not needed, proceeds can be re-invested into another investment, effectively re-basing the ‘cost’ and reducing future taxable gains.
  • If your client does not have any of these allowances available but their partner (or even an adult child) does, then bonds or bond segments can be assigned to them so that they can benefit from tax free gains. Remember, the assignment of a bond in this way is not a taxable event.
Key information

  • Details of all non-savings and savings income.
  • Investment gains on each policy segment.


10. Recycle savings into a more efficient tax wrapper

  • As mentioned in 8 and 9 above, allowances are a great way to harvest profits tax free. By re-investing this ‘tax free’ growth, there will be less tax to pay on final encashment than might otherwise have been the case. That is to say when your client’s actually need to spend their savings, tax will be less of burden.
  • But there may be a better option to re-investing these interim capital withdrawals in the same tax wrapper. For example, they could be used to fund their pension where further tax relief can be claimed, investments can continue to grow tax free and funds can be protected from IHT.
  • Similarly, capital taken could be used as part of this year’s ISA subscription. Although there’s no tax relief or IHT advantage as with a pension, fund growth will still be protected from tax.
  • Which leads nicely on to one final consideration; should ISA savings be recycled in to a client’s pension in order to benefit from tax relief and IHT protection?
Key information

  • Unused personal allowances for extracting investment profits.
  • Remaining annual ISA allowance.
  • Pension annual allowance available from current year and previous 3 years and relevant UK earnings.


Summary

Only at the end of the tax year do you have all the pieces of the jigsaw. But there are some steps you can take now to get start gathering all the information needed, to be ahead of the game, and give yourself time to put plans in place. And remember, there are less than 5 weeks until the 5th of April.

 

(Source: Standard Life Technical 2018). I am again indebted to Standard Life technical – in this case their adviser facing article has been adjusted slightly to be more consumer-friendly.

Partial DB transfers – the best of both worlds?

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Partial DB transfers could be the perfect solution for those caught between needing income security and income flexibility.

Not only could partial DB transfers offer the best of both worlds to clients, it could also be advantageous to employers and trustees too. Most people with a DB pension will be best advised to stick with it. A DB pension offers the peace of mind of a fixed income for life. It will be too much for most people to contemplate giving up, no matter what level of transfer value is on offer.

But what if the guaranteed income level needed to allow clients to sleep easily knowing that they’re financially secure can be met with only part of their accrued DB promise? Transferring the excess to provide income flexibility when required, or to be passed on efficiently to future generations, could generate a situation where everyone is a winner.

  • Member – win: For members who want some guaranteed income, but not as much as their full DB entitlement,  partial DB transfers may be the best fit for their needs. It can provide the guaranteed income they need, plus flexibility with the balance of their accumulated DB wealth.
  • Employer – win: Growing numbers of employers have realised that allowing partial transfers helps get DB liabilities off their balance sheet efficiently. If they stick with an ‘all or nothing’ stance, more liabilities will stay on their books.
  • Trustees – win: Every transfer paid normally improves their scheme’s actuarial funding position – leaving remaining members more secure. It’s rare for a transfer value to be higher than the actuarial ‘technical provisions’ they have to reserve for to back the DB promise.

Who might it be right for?
It may be clear cut whether or not partial DB transfers are appropriate for most clients. But there will be some who sit in the ‘grey area’, needing some guarantee but equally attracted to DC and the benefits that freedom and choice can offer. And it’s these clients who will benefit most from seeking a partial transfer. 

A guaranteed retirement income may provide peace of mind that the bills will be paid in old age. Giving up this guaranteed, inflation-proofed income for life could be a risk too far. Most simply can’t take on the downside risk of moving to DC and should stick with DB.

But for wealthier clients, worries about paying their bills or running out of money won’t be an issue. A DB income for life may simply mean surplus income and unnecessary tax. A transfer to a modern, flexible DC pension may be a better fit for their needs. The ability to take income and tax free cash from a SIPP at the levels they need, when they need it, may give a more tax efficient income and a larger legacy for loved ones.

The advice framework – and how partial transfers fit in
The FCA rules are clear. An adviser’s starting assumption should be that a DB transfer isn’t suitable. A transfer to DC should only be recommended if it’s clearly in the client’s best interests.

This doesn’t mean it’s safe to leave clients in DB where DC would suit them better. But it gives advisers a useful ‘no transfer’ default for cases in the grey area – and some leeway over where they draw the line.

However, where a partial DB transfer is an option, this changes the advice equation – and can remove any grey area. Although a full transfer may not be appropriate, a partial transfer might meet the client’s needs and aims better than sticking with the full DB pension.

Example – A client with a £40k yearly DB pension may only need a guaranteed income of £24k. A transfer value of £1M is on offer in lieu of the pension. But the client couldn’t sleep at night without their guaranteed £2k a month.

  • No transfer: Sticking with the full DB pension provides the guaranteed income the client needs. But it also gives an extra £16k a year unneeded income, an unnecessary income tax bill and, potentially, an IHT problem further down the line.
  • Full transfer: Transferring it all into flexible DC won’t guarantee the required £24k a year – risking a bad client outcome, regulatory sanction and lost sleep all round. And in current conditions, partial annuitisation under DC post-transfer to secure the £24k a year may not make economic sense.

What if a partial transfer was available?

  • Partial transfer: Leaving £24k a year guaranteed income in DB, and transferring the other 40% of the value (£400k) into a flexible DC plan, could give the best of both worlds. It covers the client’s guaranteed income needs efficiently and gives flexibility to draw extra funds when needed, manage tax or create a legacy with the balance. The ideal advice solution?


Will schemes offer partial transfers?
Many schemes don’t currently offer the option of a partial DB transfer. It simply wasn’t historically a feature of the DB landscape. But the numbers now offering partial transfers is on the rise.

The barriers holding some DB schemes back from introducing a partial transfer option are the perceived complexity and cost. Legal fees to amend the scheme documents, actuarial fees to develop a transfer basis and the costs of implementing the necessary administrative processes can all be off-putting.

But these are all achievable. If scheme trustees thought about it, they already provide partial transfers every time they receive a pension sharing order. It’s just about industrialising the process. And the payback for all concerned could be worth it.

Clients with DB and DC rights under the same scheme now have a statutory right to transfer their DC rights and leave the DB pension behind (or vice versa). An ‘all or nothing’ transfer ultimatum doesn’t always support the best member outcomes. It’s why the law was changed to allow DB and DC rights to be transferred independently. But there’s currently no statutory right to make a partial transfer of DB rights.

There are some potential legislative obstacles which may prevent a partial DB transfer. For example, the law doesn’t allow for a partial transfer of GMP rights. And scheme specific protection to both tax free cash entitlement and early retirement ages may be affected following a partial transfer. But there are normally ways to plan around these.

In summary
If this ‘best of both’ option is the best fit for your client’s needs, ask the question of the DB trustees – does their scheme offer partial transfers? And if not, ‘why not?’ By articulating the win/win result this option can produce, it might just trigger a light bulb moment for the employer/ trustees that opens up the most appropriate option for your client and creates the best advice solution for you.

retirement-options-guide-couple

Partial DB transfers – the best of both worlds?

 

Source: Standard Life technical consulting 10th May 2017

Pension contributions – How they can help business owners.

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How pension contributions can help business owners

The dividend tax changes have strengthened the case for business owners taking more of their profits in the form of pension contributions. Many directors of small and medium sized companies face an increased tax bill this year as a result of how dividends are now taxed. And pension contributions could provide the best outcome by cutting their future tax bills.

Dividends have long been preferable to salary or bonus as a way for shareholding directors to extract profits. But that advantage has narrowed for many high earning directors. It reinforces the case for directors taking at least part of their benefits as a pension contribution where possible.

Dividend changes

Paying themselves dividends remains a better option than salary. But the gap has narrowed for high earning directors. A director receiving a dividend of £100,000 could be £6,300 worse off under the new rules.

Everyone now gets a £5,000 tax free dividend allowance. Dividends in excess of the allowance will be taxable at 7.5%, 32.5% or 38.1%. Previously, business owners only paid tax on dividends when they took income above the basic rate tax band. That’s because the notional 10% tax credit satisfied the liability for basic rate tax payers. But the changes mean that business owners could now be paying a higher rate of tax on a larger slice of their income.

Tax efficient extraction

Pension contributions remain the most tax efficient way of extracting profits from a business. An employer pension contribution means there’s no employer or employee NI liability – just like dividends. But it’s usually an allowable deduction for corporation tax – like salary.

And of course, under the new pension freedoms, those directors who are over 55 will be able to access it as easily as salary or dividend. With 25% of the pension fund available tax free, it can be very tax efficient – especially if the income from the balance can be taken within the basic rate (but remember, by doing so, the MPAA will be triggered, restricting future funding opportunities).

In reality, many business owners will pay themselves a small salary, typically around £8,000 a year – at this level, no employer or employee NI is due and credits will be earned towards the State pension. They will then take the rest of their annual income needs in the form of dividend, as this route is more tax efficient than taking more salary. But what about the profits they have earned in excess of their day to day living needs?

The table below compares the net benefit ultimately derived from £40,000 of gross profits to a higher rate taxpaying shareholding director this year.

  Bonus Dividend Pension income
taxed at 20% *		 Pension income
taxed at 40% *
Gross profit  £40,000 £40,000 £40,000 £40,000
Pension contribution  £0 £0 £40,000 £40,000
Corporation tax at 20%  £0 £8,000 £0 £0
Dividend  £0 £32,000 £0 £0
Employer NI £4,850 £0 £0 £0
Gross bonus £35,150 £0 £0 £0
Director’s NI (£703) £0 £0 £0
Income tax (£14,060) (£10,400) ** (£6,000) (£12,000)
Net benefit to director £20,387 £21,600 ** £34,000 £28,000

* Assumes pension income is taxed after taking 25% tax free cash, and there is no Lifetime Allowance charge.
** Assumes full £5,000 annual dividend allowance has already been used against dividends received in the basic rate band.

Tapered Annual Allowance

Many high earning business owners could see their annual allowance (AA) tapered down to just £10,000. However, by reducing what they take in salary or dividends and paying themselves a larger pension contribution instead could mean they retain their full £40,000 AA.

For example – Amy, 55, runs her own business and pays herself dividends of £150,000 for the 2016/17 tax year. She has no other income. She makes employer contributions of £20,000 into her SIPP.

There are two tests which determine whether the AA is tapered:

  1. If adjusted income is more than £150,000 the AA is reduced by £1 for every £2 subject to a minimum allowance of £10,000
  2. But only if the threshold income is greater than £110,000.

Her ‘adjusted income‘ is £170,000 (income + employer pension contribution). As this is £20,000 above the £150,000 cap, it would normally cut her AA by £10,000 (to £30,000). This means any opportunity to increase her funding for this year, or in the future using carry forward from 2016/17, would be limited to a further £10,000.

However, if she cuts her dividends by just over £40,000 her ‘threshold income’ (total income without employer contributions) would be below £110,000, preserving her full £40,000 allowance.

She could pay the corresponding amount into her pension as an employer contribution using carry forward of unused AA from previous tax years.  This would not affect her AA for 2016/17 because only employer contributions as part of new salary sacrifice arrangement are used to determine threshold income. A shareholder director making an employer pension contribution rather paying salary or dividend is not salary sacrifice.

As Amy is over 55, she has unrestricted access to the funds in her SIPP. If she made use of the new income flexibilities she would trigger the money purchase annual allowance (MPAA) cutting her future funding to £4,000 a year from April 2017, with no opportunity to use carry forward. However, if she only touches her tax free cash and takes no income she would retain her full AA.

Why now?

There are some very strong reasons for maximising pension contributions now. Corporation tax rates are set to fall from 20% to 19% from the financial year starting April 2017, with a further planned cut to 17% from April 2020.

Companies may want to consider bringing forward pension funding plans to benefit from tax relief at the higher rate. Payments should be made before the end of the current business year, while rates are at their highest.

Business owners who take flexible drawdown  income to replace salary or dividends will see their future funding restricted by the MPAA. So they may need to pay now and mop up any unused allowance using carry forward. But remember that dipping into pension savings by only taking tax free cash maintains the full allowance for ongoing funding.

Source: Standard Life technical consulting – February 22 2017 

MPAA and Dividend Allowances cuts delayed as Finance Bill trimmed

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Some elements of the Finance Bill will not go ahead as planned as a consequence of the early general election. With Parliament due to be dissolved on 3 May it was deemed there was insufficient time to get the current Finance Bill in its entirety on to the statute book.

The following measures, which may affect the advice you are providing to your clients, have been removed from the Finance Bill:

Changes which intended to apply in 2017/18

Reduced Money Purchase Annual Allowance (MPAA)
The Money Purchase Annual Allowance (MPAA) will not now be cut from £10,000 to £4,000 at this time. This reduction would have affected those who have accessed their DC pension under the new pension flexibilities and wish to continue paying into their pension.   Edit: The MPAA was indeed reduced to £4,000 for 2017-18 after all!

Deemed Domicile Rule Changes
Rules were to be introduced from April 2017 to reduce the number of years non-doms can be resident in the UK before becoming deemed domicile. Currently someone would become deemed domicile in the UK for inheritance tax after they have been resident 17 out of 20 tax years but it had been set to fall to 15 years. It was also intended extend the scope of the deemed domicile rules to also apply to income tax and CGT.

Recalculation of Disproportionate Bond Gains
Measures which would have put an end to chargeable gains on a part surrender of an investment bond have been shelved. From April 2017 HMRC had planned to allow gains which were wholly disproportionate to the investment performance to be recalculated on a just and reasonable basis. This would typically arise where a large part surrender in excess of the 5% allowance is made in the early years of the policy.

Changes which intended to apply in 2018/19

Dividend Allowance Cut
From April 2018,  the annual dividend allowance is set to be cut from £5,000 to £2,000. This is no longer part of the current Finance Bill. This would hit small and medium sized business owners who take their profits as a dividend.

What happens next?

While all these changes no longer form part of the condensed Finance Bill it is intended that they will be reconsidered once a new Parliament commences and could form part of the new Government’s first Finance Bill, meaning they may be delayed rather than dropped altogether.

Source – Standard Life

Higher Earners – are you affected by the new tapered (restricted) tax relief on pension contributions? Read on for Possible Solutions…

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My previous post November 23rd 2016 set out the rules for the tapered annual pension contributions allowance. Many higher earners are getting to grips with this and seeing that their ability to obtain (higher / additional rate) tax relief on pension contributions is severely restricted. This is bonus season, and a recent bonus may push you into this tapering calculation for your allowable pension contributions.

This is the first year of operation and  where an individual did not maximum-fund his pension contributions in previous years, they can use up available headroom from the previous three years (after first making maximum contributions in the current tax year). The maximum annual allowances are:

2016/17: (current tax year) £40,000 or as low as £10,000 if subject to tapering

2015/16: £40,000

2014/15: £40,000

2013/14: £50,000

So provided an individual was UK-based AND a member of a UK pension scheme at the time (regardless of whether  any contributions were made) in those three previous tax years, if their aggregate gross pension contributions (including employer contributions) were below the annual allowances, then the headroom can be carried forward and used in the current tax year. To do so, one must first use the current year’s, then you may go back up to three previous tax years, using the oldest first. As you can see, after we pass into a new tax year, the oldest of the three years falls away. Therefore, even if you cannot fully fund all of the headroom available, it would be sensible (where funds permit) to fund the current year and then go back and use the remaining allowance from three years ago – 2013/14 as it currently stands.

Give me a call if you have questions or need help with the calculations – 0345 013 6525.

Where carry forward is exhausted, higher earners may wish to look elsewhere for tax efficient long-term investments. These will include ISAs, Venture Capital Trusts (VCTs), (Small) Enterprise investment Schemes (SEIS and EIS),  investment bonds (onshore and offshore), maximum investment plans and other vehicles. Not all types of investment are suitable to an individual, so advice is needed when considering them.

I’ll be blogging more about these areas as we approach tax year-end, but since demand is high if you are contemplating making a last minute lump sum contribution into pension I suggest you do so several working days before April 5th, 2017 to ensure properly received and recorded by the pension provider.

The obscene lifestyles of the new global super-rich

 

Annual Allowance for Pension Contributions: The Tapering rules

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Tapering of annual allowance for high incomes

Source – Royal London – pensions technical, 2015.

 

This measure restricts pension tax relief by introducing a tapered reduction in the amount of the annual allowance for individuals with an adjusted income of over £150,000 and a threshold income over £110,000.

Key facts

  • The annual allowance will be reduced for individuals who have ‘adjusted income’ over £150,000 a year.
  • The reduction in the annual allowance is not a flat rate but reduces by £1 for every £2 over £150,000
  • The maximum reduction is £30,000
  • The reduction does not apply to individuals who have ‘threshold income’ of no more than £110,000.

 

Since 6 April 2016, individuals who have taxable income for a tax year of greater than £150,000 will have their annual allowance for that tax year restricted. It will be reduced, so that for every £2 of income they have over £150,000, their annual allowance is reduced by £1. Any resulting reduced annual allowance is rounded down to the nearest whole pound.

The maximum reduction will be £30,000, so anyone with income of £210,000 or more will have an annual allowance of £10,000. High income individuals caught by the restriction may therefore have to reduce the contributions paid by them and/or their employers or suffer an annual allowance charge.

However the tapered reduction doesn’t apply to anyone with ‘threshold income’ of no more than £110,000.

Clearly the definitions of the two incomes are crucial to understanding whether someone is affected by the tapered reduction or not.

Adjusted income v threshold income

Both include all taxable income. So this is not restricted to earnings – investment income of all types and benefits in kind such as medical insurance premiums paid by the employer will also be included.

The difference is pretty simple; adjusted income includes all pension contributions (including any employer contributions) while threshold income excludes pension contributions.

Unfortunately, HMRC’s definitions of adjusted and threshold income tend to cause a bit of confusion because they start with something called ‘net income’. A common sense meaning of this would be ‘income after tax’, but it’s not.

Net income in this context is all taxable income less various deductions. The most important (or at least the most common) of these deductions are member contributions paid to an occupational pension scheme, both money purchase and defined benefit, under the net pay arrangement. This is where the sponsoring employer of the pension scheme deducts employee contributions before deducting tax under PAYE.

The other deductions are things like trade losses, share loss relief and gifts to charities.  A full list of the deductions can be found at s.23 of the Income Tax Act 2007.

However it all becomes a bit easier if we consider taxable income from a more practical view point.

When someone says ‘I earn £x p.a.’, they don’t usually mean that that’s the amount after the deduction of net pay arrangement contributions. We can therefore assume that when someone has earnings of £160,000 and pays contributions of £20,000 under the net pay arrangement, they’ll state their earnings as £160,000, not £140,000. The £160,000 includes the pension contributions.

This is therefore a good place to start for calculating adjusted income (which includes pension contributions). For threshold income, all member pension contributions need to be deducted and you wouldn’t add in employer contributions.

Calculating adjusted income and threshold income

*for a DB scheme, this would be the pension input amount less any employee contributions.

Example

Phil is a company director and sole shareholder of his own company.  His taxable income is £100,000 and he decides to pay an employer contribution of £60,000 (using carry forward to avoid an annual allowance charge).

His adjusted income is therefore £160,000 which would on the face of it trigger a reduction of £5,000 in his annual allowance (half of the £10,000 excess over £150,000).

However his threshold income is only £100,000 and so the tapered reduction does not apply.

Anti-avoidance

To avoid individuals entering into a salary exchange or a flexible remuneration arrangement after 9 July 2015 so they received additional pension contributions but reduce their adjusted or threshold income anti-avoidance rules have been put in place.

The anti-avoidance rules apply if:

  • It is reasonable to assume that the main purpose for the change to the salary exchange or flexible remuneration agreement is to reduce the individual’s adjusted or threshold income (this includes any reductions to nil).
  • The change affects their income in either the current tax year or two or more tax years, including the current tax year.
  • In return for the income being reduced the individual receives an increase in their adjusted or threshold income in a different tax year.

If the anti-avoidance rules apply then the income used to calculate the reduction to the annual allowance for that tax year is the one before any adjustments were made.

Carry forward

It’s still possible to carry forward unused annual allowance from previous years to a year where the taper applies.

However the amount of unused annual allowance available when carrying forward from a year where the taper has applied will be the balance of the tapered amount.

Flexible drawdown

Where an individual flexibly accesses their pension savings they are subject to the money purchase annual allowance.

Individuals who have flexibly accessed their pension savings will continue to have a money purchase annual allowance of £10,000. But where this applies, the alternative annual allowance (normally £30,000), against which their defined benefit savings are tested, will be restricted by the same taper.

This means that those with incomes of £210,000 or more will have an alternative annual allowance of £0 although any available carry forward can be added to this.

Money purchase annual allowance (MPAA)

If someone is subject to the MPAA as well as tapering, the taper reduces the ‘alternative annual allowance’ which applies to any DB benefits they may have.  This is the standard annual allowance less the MPAA of £10,000, so currently the alternative annual allowance is £30,000.

………… (Royal London – July 2015)