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Pensions:
a brave
new world
About this time last year I wrote an article outlining the new regulations affecting pensions. While preparing this article, I took the opportunity to re-read those words and was delighted to see that I had included a warning that fundamental changes could still occur. In fact my words were: “The government and its agencies will still make fundamental changes if it feels that there is a chance that legislation will be abused . . . the Revenue has made it quite clear that it will have no hesitation in using the new pension tax charges totalling up to 70% to penalise transgressors”.
The Pre-Budget Report issued in December 2006 contains draft legislation that, if carried through, significantly changes certain aspects of pension planning and strategy. The Chancellor’s statement has caused life assurance companies to immediately withdraw individual life assurance policies written under pensions legislation. Prior to the announcement, premiums paid on such policies were fully deductible against an individual’s taxable earnings and as such policies could be written in trust, provided that cash benefits were outside the pension member’s estate for the purposes of Inheritance Tax. The government sees such use of the pensions legislation as inappropriate and has quickly moved to outlaw such stand-alone policies.
While such a step reduces flexibility for individuals, stand-alone insurance policies are still available for groups of individuals and so employers are not prevented from continuing to offer this benefit. Furthermore, for those individuals whose employer offers a flexible benefits package, it is possible to create tailored levels of life assurance for each member of the scheme. The downside is that the individual ceases to benefit from the arrangement as soon as they leave the employer’s service. Given the levels of borrowing needed to purchase residential property in the UK, it is not difficult to see employers receive an increasing number of demands for such benefits in future.
At the other end of the time scale are the changes that the government intends to put in place for individuals who do not wish to purchase an annuity, but rather to receive a pension income directly from their funds. Since the Finance Act of July 2006, we have known that for those aged over 75 individual pension funds will form part of their estate for Inheritance Tax purposes, and that the net capital can only be passed to other pension funds administered by the same company. However this level of taxation has not been considered as sufficient and the government now proposes that such transfers are deemed to be unauthorized payments and therefore subject to an exit penalty charge of 70%. In addition the net 30% of the fund that remains will still be subject to Inheritance Tax at 40%. The overall tax charge is therefore 82%. It is said that there are two things that are certain in life: death and taxes. However, this is the first time that I have ever heard of death being deemed to be a tax abuse. As with the matter of pension life assurance, it is possible to devise strategies to avoid the problem, but this increase in complexity does mean that pensions are not so simple as they were intended and expert advice should always be sought at an early stage.
 Pension funds may buy or sell assets from and to their members |
I began this article by outlining the negative changes that have been made to the new legislation to demonstrate quite clearly that the authorities will not allow pensions legislation to cause significant tax leakage, and will react quite swiftly where they see changes required. However, the regime continues to allow significant tax advantages for individuals resident in the UK who wish to build a fund for retirement income. Annual contribution limits are, for the majority of people, still greatly above those offered by the previous legislation. The current tax allowable contribution limit is 100% of salary up to a maximum of £215,000. Furthermore, for the current tax year end 5 April 2007, it is possible to establish a scheme that allows a double contribution to be made, so taking the maximum possible tax allowable contribution to £440,000.
The option of using self-invested arrangements to control and direct investment policy is available to pension members. As pension funds can still arrange borrowing for up to 50% of their net assets and individual arrangements can link together to increase their buying power, it is possible to create a significant capital fund to benefit from tax reliefs at the highest marginal rate. Whilst the legislation now limits the range of assets that a pension fund may own, there is still plenty to choose from, virtually any form of quoted financial instrument may be owned, as may shares in unquoted businesses.
A further benefit is that the pension fund may buy or sell assets from and to its members. This means that an individual may pay tax-allowable contributions to their pension scheme, gain significant tax reliefs, and then use those tax-free funds to buy an asset from themselves, so effectively both retaining the asset and increasing their own personal cash funds. Alternatively an individual may choose to buy assets from a pension scheme in order to gain other advantages, for example when a commercial property may be developed for residential purposes. The new legislation also allows contributions to be made in specie. Subject to the same contribution limits as cash payments, in specie contributions allow individuals to maximise tax reliefs even if they do not have sufficient liquid funds.
All these reliefs and opportunities are available to anyone who is working and living in the UK. Should those pension members then choose to leave the UK it is still possible to transfer their pension funds to foreign arrangements. As the labour force becomes increasingly internationally mobile the ability to transfer pension funds between regimes will be seen as a significant advantage that encourages good-quality employees to come to the UK. Employers should therefore consider the inclusion of pensions and pensions life assurance into their remuneration packages for, notwithstanding the latest changes made by the government, the pensions regime in the UK does offer an excellent way to build a tax-free savings fund that continues to allow a significant degree of flexibility.
For more information, contact:
Eric Clapton
FW Stephens Financial Limited
Tel: +44 (0) 20 7382 1820
E-mail: eric.clapton@fwstephens.co.uk
Website: www.fwstephens.co.uk
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