Traditionally Christmas is a time to relax, but it is also an ideal opportunity to use any downtime to discuss pension planning in advance of the tax year-end, coupled with the popular company year-end of 31 March. With this in mind, here are 12 suggestions for clients to increase their retirement savings.
1. Maximise pension contributions while you can
The maximum tax relievable personal contribution to a pension plan is 100% of relevant UK earnings or £3,600, whichever is the higher. If you have had the misfortune of having your job made redundant recently, it makes sense to contribute to a pension plan before the end of the tax year.
Many individuals consider investing some of their redundancy payment, especially any amount over the first (tax-free) £30,000. If a redundancy payment greater than £30,000 is received and added to 2009-10 income earned before redundancy, higher rate tax may be due on a considerable amount of money.
However, earnings for 2010-11 could be far lower or even nil, in which case the contribution would be limited to £3,600. Those wanting to obtain higher rate tax relief may need to contribute before the end of the tax year.
2. Salary exchange (not sacrifice)
In the past, it has sometimes been difficult to gain employees’ support for this idea because ‘sacrifice’ implies something is being given up or lost. This is not the case: an exchange is taking place, value is not lost, and it is important this is realised.
A reduction in earnings means a reduction in national insurance (NI) payments and these savings can be used to provide benefits in a number of ways. If the employee and employer NI savings are added, the employer pension contribution could be up to 31% higher than receiving the salary and paying a personal contribution.
For higher rate taxpayers who opt for salary exchange, the increase in contribution would be lower (14.7%) but there would be the added benefit of tax relief at source.
3. Use input periods
Key points to be aware of include:
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All registered pension schemes have a pension input period.
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The pension input during a pension input period is compared to the annual allowance for the tax year when the period ends.
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In a money purchase scheme, the member may choose to end the pension input period less than 12 months after the start.
Case study
Mary runs her own business. A pension plan commences on 15 March 2010 with a £245,000 employer contribution. Mary nominates to end the input period on 19 March 2010. The contribution is tested against the annual allowance for the tax year in which the input period ends (2009-10).
Mary’s second pension input period starts on 20 March 2010 and on that day her employer contributes £255,000, which is tested against the annual allowance for 2010-11. Mary nominates to end this second input period on 6 April 2010 (there must only be one input period end per arrangement in each tax year).
The third input period starts on 7 April 2010 and ends on 7 April 2011 (in 2011-12). Any contribution paid between these dates is tested against the 2011-12 annual allowance. It is therefore possible for Mary’s employer to pay another contribution on 7 April 2010 of £255,000.
This means £245,000 is paid on 15 March 2010, £255,000 a few days later on 20 March and £255,000 on 7 April, a total of £755,000 of company contributions in a matter of days. (The contributions need to be acceptable to the local inspector as ‘wholly and exclusively’ for employer tax relief to be given).
Anti-forestalling effect
Contributions of this level will not necessarily make sense if relevant income is more than £150,000 because anti-forestalling will bring a special annual allowance charge and a hefty personal tax bill.
However, if relevant income is less than £150,000 in the current and previous two tax years, then the anti-forestalling regulations will not apply. But remember, relevant income includes investment income, not just earnings from employment.
4. Carry back trading losses
Where a company makes pension contributions, valuable corporation tax relief can be secured, even when they are made during a loss-making accounting period.
Where pension contributions are allowable as a deduction against corporation tax, any trading loss can be set against profits from the previous year and, following the 2008 pre-Budget report and 2009 Budget announcement, the two years preceding that year. The ‘carry back’ relief extension means a tax refund can be received earlier.
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Claims are possible for companies making returns for accounting periods between 24 November 2008 and 23 November 2010.
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Losses are offset against the preceding year first and the amount able to be carried back to the first preceding year is unlimited.
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A maximum of £50,000 of the balance of any unused losses can be carried back to the two earlier years.
Trading losses may also be carried forward to set against future profits. As long as the company paid corporation tax in the previous three accounting periods or will be paying it in subsequent periods, tax relief will be applied to pension contributions provided they are made wholly and exclusively for the purposes of the trade.
Consider reviewing cases in which a trading loss has been made between these dates to ensure this valuable planning opportunity is not overlooked.
5. Claim higher rate tax relief
Personal contributions to pension plans are often paid out of net pay and grossed up by basic rate tax relief. For higher rate taxpayers, the difference between higher and basic rate relief is reclaimable when completing a self-assessment tax return.
The difference between higher rate and basic rate can be claimed by completing and returning a self-assessment tax return. If members do not do this, they may not receive the tax saving that is due.
6. Contribute at least £20,000 (this year and next)
It is a good idea to remind clients of the cost of delaying pension contributions and the possible effects on future retirement provision.
Case study
(For illustrative purposes, assume a growth rate of 7% each year and an annual management charge of 1%)
John has relevant income of £200,000 for 2009-10. He is aged 50 and intends to take his pension benefits at age 65.
If he paid £20,000 gross in 2009-10 and 2010-11, these contributions could be worth £92,260 at age 65. The effective cost would be £22,000 (£20,000 less 40% tax relief plus £20,000 less 50% tax relief).
If payment is deferred until 2011-12, then using the same assumptions, a contribution of £40,000 could be worth £84,588 at age 65. The cost to John would be £32,000 (£40,000 less 20% tax relief).
John’s choice is to pay a total of £22,000 net over 2009-10 and 2010-11, or pay nearly £35,000 net in 2011-12 to achieve the same potential fund value at age 65.
7. Third party contributions
This offers considerable scope for inheritance tax (IHT) and pension planning with the advantage that a donor can gift money in their lifetime without any possibility of IHT (subject to surviving seven years) while making pension provision for future generations.
The value of the gift is enhanced by basic rate tax credit when it is paid into the pension plan. The donor does not need to worry about beneficiaries frittering away the monies because access to the funds is not normally available until age 55.
8. Manage relevant income
Anti-forestalling introduced a relevant income threshold of £150,000 (and a special annual allowance of £20,000). Anyone with lower relevant income is not affected by the rule changes. But even if this year’s income is less than £150,000, it may have been higher in either of the previous two tax years.
Assuming that relevant income for all three years is less than £150,000, there are a number of pension planning issues and opportunities:
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Salary exchange will continue to be attractive as a means of reducing tax and NI contributions, for those with relevant income of less than £150,000.
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Maximise personal contributions. Anyone with relevant income of less than £150,000 can pay up to 100% of their relevant UK earnings and get tax relief at their highest marginal rate.
* Let the employer make the contribution. Contributions from an employer are not normally added back in to the calculation of relevant income. So it is possible for relevant income to remain below £150,000 and employer contributions to be paid up to the annual allowance or even beyond.
9. Retain your personal allowance in 2010-11
If adjusted net income is more than £100,000, the basic personal allowance will be reduced or removed entirely. A pound of personal allowance will be lost for every £2 of income earned over £100,000. All personal allowance will be lost when earnings equal approximately £112,950 (assuming the current personal allowance), giving an effective 60% tax rate.
Adjusted net income is taxable income reduced by specified deductions (such as trading losses and payments made gross to pension schemes) as well as grossed-up gift aid and pension contributions that have received tax relief at source. Provided an individual’s adjusted net income is not more than £100,000, they will continue to be entitled to the full amount of the basic personal allowance.
Making a personal pension contribution would reduce adjusted net income, which not only reduces the higher rate tax liability, but could also mean retaining the full personal allowance and effective tax relief of up to 60%.
10. Bed and Sipp
Approved share option plans can be rolled over on maturity into a pension arrangement and deliver a tax relief top-up. It may also be possible to encash other types of assets and securities, and invest the proceeds into a pension plan that offers access to a wide range of investments, such as a self-invested personal pension (Sipp).
Basic rate tax relief is added to the contribution (which may help to offset any losses) and the original investment can then be replicated as far as possible in the pension plan.
Sheltering investments in a tax-favoured wrapper, such as a pension plan or ISA, can even help to reduce relevant income and avoid the possibility of the anti-forestalling provisions biting.
11. Carry back of gift aid
The final step of calculating relevant income under anti-forestalling deducts gift aid contributions. Potentially, gift aid contributions could reduce relevant income to less than £150,000 and thereby result in not being affected by anti-forestalling.
A donation, subject to gift aid, can be backdated to a previous year if a nomination is made on the self-assessment tax return for that year, ie, before it is submitted to HM Revenue & Customs (HMRC) by either the 31 October deadline for a paper return or the 31 January deadline for an online return.
This means provided the 2008-09 tax return has not yet been submitted, a claim can still be made by 31 January 2010. HMRC Form P810 Tax Review can be used for those who do not submit a self-assessment tax return; the deadline is still 31 January 2010.
12. Income recycling
While the government’s position on recycling tax-free cash is well known, no similar action has been taken against recycling income.
The recycled income is invested in an uncrystallised pension arrangement, offering additional tax-free cash and improved lump sum death benefits, which are not subject to 35% tax or (normally) IHT.
Provided the income is reinvested immediately, all other things being equal, the total fund invested should remain the same as if no income were taken (the tax relief cancels out the income tax). However, higher rate taxpayers must be aware of the tax relief time lag. They will not have full fund replacement unless they replace the marginal higher rate tax up front from other resources before claiming the relief later.
Income recycling could be particularly useful to those who are aged 50 or over, but under 55 on 6 April 2010, who want to access their benefits before then, rather than wait up to another five years.
Recycling income into a third party’s pension is also a useful estate-planning tool. Unlike personal income recycling, this option is even possible after the age of 75, and could be useful planning for someone concerned about death while in alternatively secured pension.
Note: This was written before the 9 December pre-Budget report.
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