Spotlight on Pension Flexibility
In the Budget of March 2014, the Chancellor said that the government planned to “Introduce the most fundamental reform to… pensions in almost a century… giving people much greater freedom over how they access their pensions savings”.
A government minister speculated initially that the new proposed ease of access to pension funds after the age of 55 could lead pensioners to go out and buy a Lamborghini with their pot.
As a firm of tax advisors we feel that Pensions Flexibility brings pension contributions firmly back into the spotlight for owner managed businesses.
At tax planning meetings of the past, pension contributions were always on the agenda but the discussions around them tended to be muted. This was because monies in a pension were perceived as not being accessible.
Pension contributions for a director/owner have always been a sensible, simple way of reducing a bill for corporation tax. This, coupled with the ability to withdraw 25% of a fund on retirement, make them attractive from a tax point of view. However, the fact that the remaining monies can be withdrawn on a very flexible basis in the future now takes the barrier of money being tied up totally out of the equation.
The additional benefit of money in a pension scheme being outside of the individual’s Inheritance Tax Estate makes the landscape even better. This has led to commentators stating that a pension scheme will be the first investment pot to fill up and the last one to empty.
Mr X is 55 and has a trading company with cash reserves of around £300,000 and makes annual profits. He wishes to retire from the business in 5 years and he will either liquidate the company or aim to sell it. He has other income that utilises his annual personal allowance for income tax.
He is unwilling to put the cash reserves of the company into an investment of any nature because this could dilute his right to entrepreneurs’ relief on a sale/liquidation. Therefore little / if any growth is expected on the cash.
If he makes a pension contributions to a personal pension scheme then the money in the pension scheme has a better chance of growing and the tax analysis is as follows for a £10,000 contribution:-
Transfer to pension scheme £10,000
Illustrative Growth over 5 year £1,000
25% tax free cash in his hand on retirement £2,750
Balance of monies received net of 20% income tax £6,600
Total monies received in hand out of £10,000 £9,350
Comparative calculations for £10,000 of profit which remains in the company and is withdrawn on liquidation or sale:-
Less corporation tax (£2,000)
Illustrative Growth over 5 years £80
Cash left in the company £8,080
Less 10% capital gains on withdrawal of the cash (£808)
Total monies received in hand out of £10,000 £7,272
The calculations demonstrate clearly the tax benefits of a pension contributions on the director’s behalf over leaving money in the company.
Of course there are warnings and the Pensions Flexibility legislation has not yet been passed and there are technical matters that will need to be discussed with a pensions advisor. However, for the moment pension contributions are back on the radar for owner managers and high earners.
See our December 2014 Tax Update for more recent cases.