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

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

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?

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.

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

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)

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).

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

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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