|
The
first choice for people in pensions Pensions
Age has been designed to provide pensions professionals with a single
and authoritative source |
|
A
wealth of opportunity Stakeholder pensions are a key part of the government’s attack on pensioner poverty in the UK. It has particularly targeted moderate earners – broadly those earning between £10,000 and £20,000 a year – to ensure they make some provision for themselves. The biggest success story of stakeholder so far has been a completely different group – those with substantial assets who are making use of tax-planning opportunities raised by the new personal pension contribution rules. This means that many who were previously unable to contribute to a personal pension because they had no relevant earnings, or who could only pay in a very small amount, can now contribute up to £2,808 a year net (£3,600 gross) into a personal or stakeholder pension. There are many opportunities for advisers discussing financial planning with wealthy clients, and these may be best illustrated through an example. The controlling director Colin is 52 and owns a small manufacturing company with yearly profits of £150,000. He has previously saved for his retirement through executive pension plans, and has taken a mixture of salary and dividends, on the advice of his accountant. Colin can now use the new rules to reduce his tax bill. In tax year 2001/2002, Colin pays himself a salary of £95,400 (the pensions earnings cap for the year). He starts a personal pension plan and pays the maximum contribution for his age, which is £28,620 (30 per cent of £95,400). In tax years 2002/2003 to 2006/2007, Colin can draw a much lower salary, and take the bulk of his income as dividends. However, by using 2001/2002 as his ‘basis year’ he can use his £95,400 earnings to maintain his contribution of £28,602 in tax years 2002/2003 to 2004/2005. By 2006/2007, when he has reached the age of 56, he can increase his contribution to £33,390 (35 per cent of £95,400). In 2007/2008, if he is still working he can either increase his salary again or reduce his pension contributions to £3,600. Colin’s company can make the personal pension contributions, without paying national insurance contributions. Assuming that Colin’s marginal income tax rate is 40 per cent, and that the company’s corporation tax rate is 20 per cent, he receives at least 11.9 per cent more in benefit at the same cost to the company than if he had taken the income in salary. Effectively, the company pays less in national insurance contributions hence, a saving. The working spouse Colin employs his wife Debbie part-time to help with administration. She earns £86 a week during the tax year 2001/02, which keeps her below the threshold for tax and national insurance. Debbie is eligible for a concurrent executive pension and stakeholder pension because she earns less than £30,000 a year and isn’t a controlling director of the company. Colin’s company contributes £1,500 a year into an executive pension plan set up for Debbie based on a maximum funding calculation. The company also contributes £3,600 a year to a stakeholder plan for Debbie. Both payments should reduce the company’s corporation tax bill. This reduction in the business tax bill depends on the tax district accepting that the pension contributions are wholly and exclusively paid for the purpose of the business – a tax deductible expense. From April 2002, Debbie will qualify for the new State Second Pension (S2P) because her earnings are above the lower earnings limit of £72 a week in 2001/2002. For this she is likely to be treated as though her earnings are approximately £11,000 a year, so she will build up a significant S2P entitlement. This means that Debbie is building up significant pension benefits from three sources – her executive pension, her stakeholder pension and (from April 2002) the State Second Pension. Her pension plans grow in a tax-efficient environment, and she can take part of her benefits as tax-free cash when she retires. After retirement she may well be a basic rate taxpayer, so the tax position is more favourable for the couple than extra pension for Colin. The student Colin and Debbie’s daughter, Sarah, is a 20-year-old student. Colin employs her to do administrative work over the summer, and the company pays £3,600 into a stakeholder plan for her. This further reduces company profits, and hence the corporation tax bill provided the Inland Revenue accept that the payment is wholly and exclusively for the purpose of the business. Sarah has pension provision started early, when it has a long time to grow. Assuming investment returns averaging 2 per cent above earnings inflation (after charges), a pension contribution made at the age of 20 is worth twice as much in real terms as an equivalent contribution made at 55. If Colin had paid Sarah £3,600 extra to enable her to contribute to the pension, she and the company would have a national insurance liability on at least part of that income. Early retirement Colin decides to retire early on 1 May 2006. He encashes his total pension savings, including those from the personal pension and his earlier executive pension arrangement. This gives him a retirement income of £60,000 a year after tax from an income drawdown plan. This £60,000 a year represents 100 per cent of the GAD maximum that Colin is allowed to take from his income drawdown plan. He estimates that he and Debbie will need £40,000 a year after tax to live on. They decide not to encash her plans in the meantime. Although Colin’s earnings have stopped, he can still contribute using his current ‘basis year’ for a further 5 tax years – from 2007/2008 to 2012/2013. He can therefore pay the £20,000 a year net (£25,641 gross) without breaching the limits. As a higher-rate taxpayer he will also be able to claim £4,615 further relief in his tax return. Colin’s new personal pension fund will, when vested, produce a further 25 per cent of tax-free cash. Although the pension will be subject to tax (probably at the higher rate), the combination of tax relief and tax-free cash effectively means that for every £6 Colin pays into his plan he gets £7 back, ignoring growth and charges. In addition to the income tax benefits, the fund returned from Colin’s new personal pension plan should be free of inheritance tax if he dies before he starts benefits. His income drawdown plan should similarly be free from inheritance tax on his death. However,
he may wish to consider setting up a trust to which he nominates
that the death benefits are paid. This would help to preserve the
proceeds from inheritance tax should Debbie die shortly after him.
An appropriate kind of trust for this is sometimes known as a ‘spousal
bypass trust’. Colin would set this up with the children and Debbie
as possible beneficiaries, with a facility for the trustees to make
loans to beneficiaries. Any loan made to Debbie would be repayable
on her death and would be a debt against her estate for inheritance
tax purposes. These opportunities, and others like them, may have
been an unintended consequence of the new personal pension rules,
but they provide a real chance for advisers to add further value
for well-off clients. For many, maximising contributions to personal
or stakeholder pensions could be as important as utilising the annual
ISA allowance. Ian Naismith is head of marketing & sales – technical
at Scottish Widows
|
 |
|