Pension contributions – How they can help business owners.

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

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…

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

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)

Where next for the UK Economy?

The UK Economy: Artemis Fundmanagers’ CEO Peter Saacke gives his opinion on about Sterling’s recent fall and where the UK economy might be headed in 2017.

Please note this is not necessarily DFM’s opinion. We do however expect to see imported inflation fairly soon, and some tough decisions for the Bank of England.

M&G Feeder of Property Portfolio Fund

M&G Feeder of Property Portfolio Fund will lift its current suspension of trading from 12 noon Friday November 4th, 2016. Trades can be placed up to 24 hours before that, for a November 4th trade date.

The fund of course feeds M&G Property Portfolio.

It appears the main property fund which remains suspended at the current date is Aviva Property Trust (formerly Norwich Union Property Trust).

M&G-Feeder-of-property-portfolio-fund-reopening

M&G Feeder of Property Portfolio Fund is opening for business again!

 

Property Funds are Opening Up Again!

Property Funds – Suspensions as at 27/09/2016:

The following property funds will resume dealing for the valuation point on the dates stated below.

Threadneedle UK Property Authorised Trust (Feeder) – Monday 26 September 2016
Henderson UK Property PAIF Feeder – Friday 14 October 2016
Standard Life UK Real Estate Feeder – Monday 17 October 2016

The following UK property funds are still suspended:

Aviva Investors Property Trust
M&G Feeder of Property Portfolio

property-funds-reopening

Busting the 5 most common Pensions Lifetime Allowance (LTA) myths

LTA – Lifetime Allowance (Pensions). This is an excellent article published by Standard Life 5/7/2016. Because it is on their adviser site you cannot follow a link to it (requires login) but I have reproduced it here because it is so current on the topic of the Pensions Lifetime Allowance (LTA).

***************************************************************************************************************

Pensions may still be the best place for savings even though individuals have reached their lifetime allowance (LTA).

handsome-couple-used-their-lta-lifetime-allowance-to-full-advantage

LTA maxed out nearly? no problem. In contemplation of a happy retirement.

And yet this appears to be a watershed for many. Pension funding is possibly being switched off due to approaching or reaching the LTA without a thought. But such drastic steps should only be taken if there is a better financial alternative.

Of course, contributions made by those with enhanced or fixed protection would result in forfeiture, and so these clients would need more careful attention of the pros and cons before re-starting any funding.

But for everyone else rapidly approaching the £1 million – should they ‘limit’ themselves or make ‘allowance’ for more funding?

Let’s look at busting five common myths that may be contributing to the perception that continued funding above the LTA is always ‘bad’.

Myth # 1 – Contributions must stop when you reach the LTA.

The key word is ‘allowance’. It is not a ‘limit’ to funding as some seem to think.

There’s nothing to prevent individuals from continuing to pay in – they still have an annual allowance available (£40,000 if not reduced by the tapering for high earners), allowing them (or their employer) to make contributions and get tax relief at their highest marginal rates. The LTA is not a barrier to pension saving or the growth on the investment, it’s the point where you have to look at what the likely tax treatment of this additional fund will ultimately mean. In this way it is no different to any other allowance such as the personal income tax allowance, annual capital gains tax allowance or the new dividend allowance – once breached, tax will be applied.

Of equal importance for all employees, if funding is stopped, there may be no alternative form of remuneration on offer to replace the employer pension contribution. This can considerably strengthen the argument to carry on funding.

Remember where an employer does offer alternative remuneration this will be fully taxable and the amount available to invest will have suffered income tax and NI.

Myth # 2 – There is a tax charge to pay as soon as the LTA is reached.

When individuals hit the LTA with their fund… nothing happens. There’s no immediate penalty, the pensions police do not coming knocking at the door. Your client just has a fund greater than the amount the allowance protects. The tax charge is only incurred when benefits are crystallised, such as when the fund is designated for drawdown.

Myth # 3 – The LTA tax charge is applied when you start to take benefits.

The charge only starts to bite when there’s not enough LTA to cover the fund that is being crystallised. Benefits are tested when they vest, a process referred to as crystallisation. Each time the individual crystallises some of their pension a percentage of the LTA is used, but the charge itself only comes into play when there’s no longer have enough LTA available to cover the amount being crystallised.

So by phasing retirement, only crystallising enough funds as are needed each year, means that the timing of the LTA charge can be managed, at least up to the age of 75 (at which point uncrystallised funds will be tested along with any investment growth on crystallised funds). When are funds over the allowance are going to be accessed – will that be during their own lifetime or after their death? These considerations will help to predict the potential tax charge on excess funds.

Myth # 4 – The penalty for exceeding the LTA is 55%

The charge is often expressed as 55%, but that is only payable if the whole of the chargeable amount is taken as a lump sum. If the individual moves it to their drawdown pot only 25% will be deducted (remember there is no tax free cash element). This would be beneficial if the income tax then applied when withdrawing an income is less than 40%, which will be the case for many clients in retirement who are able to control the level of their taxable income from effective management of tax allowances.

Will it even be the client that’ll be drawing the money? Because…

Myth # 5 – On death, there will be another LTA test on funds in drawdown

There is no 2nd LTA test on death for crystallised funds. So if the client dies before age 75 their beneficiaries will be able to inherit the pot without any further lifetime allowance charges. And of course, income they take will be tax free – so the only charge incurred was the 25% LTA charge when it was originally put into drawdown.

If the client dies after age 75 then the beneficiaries would pay income tax at their own rates on amounts drawn. So depending on their other income, this could potentially be only subject to basic rate tax, or even covered by their own personal allowance.

Summary

Bearing in mind these points, when might it make sense for your clients to continue paying into their pensions above the LTA? One key factor will be whether your client is in a workplace pension and whether there is any alternative remuneration/reward being offered.

If a contribution is coming from the employer then the cost to the employee is nil. If the individual is paying the contributions themselves, then what is the cost to them? What level of tax relief does the contribution attract? And does paying a personal contribution gain a matching employer payment?

Getting an employer contribution would seem the most beneficial – no cost to the individual and a taxed benefit is better than no benefit at all (assuming the employer contribution can’t be converted into extra salary).

Another key factor will be whether your client can get higher tax relief on contributions paid in than will be deducted when benefits (retirement income/death benefits) are paid out. If the contribution all gets 40% relief going in, but coming out is subject to the 25% LTA charge and then basic rate tax only, then the return is the same as if it had gone into an ISA. And given that headline tax rates are only part of the story, with effective tax rates taking the overall percentage lower, the actual cost of withdrawing the money could be a lot lower.

A pension income for the member is only part of the story. Funds within a pension also benefit from the fact that:

  • Investments held within the fund do not suffer further tax on income or gains, and;
  • On death, they can be passed on free of IHT to provide lump sums or pension income for any named beneficiaries. It may be that an individual does not need to rely on their pension savings in retirement, and there would be no point in taking money out and potentially exposing it to IHT at 40% on top of the other tax charges already discussed. And if the individual dies before age 75, then after any LTA charge has been dealt with, the income or lump sum would be tax free for those beneficiaries – so potentially only a 25% charge.

Ultimately, having a fund approaching the lifetime allowance doesn’t mean that pension saving has to cease. A considered approach can show that there may still be reasons to continue funding depending on the client’s circumstances. And remember from April 2018 the LTA will become inflation linked so it won’t remain £1M forever.

 

(courtesy: Standard Life technical consulting –  July 2016)

Retirement Options – How about a sensible, non-sales based guide?

The Retirement Options bible is an important read for anyone planning for their retirement. It explains the different types of retirement options available in the UK.

Whenever we deal with a client concerning retirement planning, one of the first things we do is hand them a copy of our Retirement Options bible. This is a completely factual guide to the different types of retirement options available in the UK and how they work.

It’s not a sales aid – far from it! Written by compliance people, it might be considered a tad dull, but nevertheless it is a useful text for those who are beginning to think about retiring and how to utilise their pensions.

We’re happy to send interested parties a copy for free. Just call us on 0345 013 6525 or email enquiries@dfmadvice.co.uk  giving your name address and telephone number and we’ll email you a copy. All we ask in return is that you allow us a follow-up telephone call to chat about your plans and offer our services (and the first meeting is free and no-commitment required anyway).

The Retirement Options guide outlines the different options available to you from your pension funds when you retire. It also provides useful information about the state pension and the benefits available from workplace pensions your employer may have provided for you.

You may be aware that there have been a number of changes over the last year.  This will affect the way in which you will be able to take your pension benefits. Please read the guide carefully as you consider the options now available to you.

The options described generally apply to defined contribution (money purchase) pension pots such as personal pensions, group personal pensions, self-invested personal pensions (SIPPs), and stakeholder pensions. These options are not normally available to final salary pension schemes (unless transferred first to a defined contribution pension – which, for most people, is unlikely to be advantageous).

  • members of the public please, not industry people wanting to crib from it!

retirement-options-older-man-running-on-beach

Fund News: Standard Life UK Real Estate Feeder – Suspension

Standard Life has suspended the Standard Life UK Real Estate Feeder fund (all share classes) with effect from 12 noon on 4 July 2016.

Following the EU referendum result the fund has seen an increase in outflows. In order to protect the interests of all investors, Standard Life has decided to suspend the fund. The suspension will cease as soon as practicable. Standard Life will review the suspension at least every 28 days.

Policyholders will be notified and further updates will follow.