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The implications of basis period reform for partners retiring in the next five years

What to consider when deciding your retirement date

Alex Conway, Partner, Professional Practices
21/08/2023
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If you are looking to retire in the next five years and are a partner (or a self-employed individual) then you will need to consider the impact of your retirement date. 

A question we are often asked as tax advisors by partners in professional firms is “when is the best date to retire for tax purposes?”. Historically, the answer has always been “it depends”, and is usually based on the partner's particular facts, such as final profit share, overlap profits (profits assessed twice on joining the firm) and what the partner plans to do in retirement. Therefore, a detailed analysis needs to be performed to assess the optimum retirement date.

With the introduction of “basis period reform” and the eradication of overlap profits, details of which can be found in our previous insight, many people believe the answer to this question should be more straightforward. However, that is not always the case and consideration should still be given to the tax implications of a partner’s retirement date.

Loss of spreading

As part of the transition to the new basis period of assessment for partnership profits, the “additional net profits” that arise in the 2023/24 tax year will be automatically spread over five years. 1/5th of the additional net profits will be taxed in 2023/24, as well as the four subsequent tax years, with the last tax year of impact being 2027/28.

However, spreading will cease and the “additional net profits” to be assessed accelerated if a partner makes an election to do so in a tax year prior to 2027/28.

This automatic acceleration of the “additional net profits” will also occur if a partner leaves/retires from the firm before the 2027/28 tax year.

The choice of retirement date under basis period reform will therefore not only accelerate tax liabilities and tax payments but also may have other tax implications as illustrated below.

Example

Partner A is looking to retire in 2026. They are wondering whether to retire on the 31 March 2026 or in line with the firm’s year end of 30 April 2026. Their particular facts are as follows:

  • profit share for year ended 30 April 2026 will be £1.5 million and £1.375 million in year ended 31 March 2026
  • additional net profits were £100,000 meaning additional profits of £20,000 a tax year as part of basis period reform
  • no consultancy work/minimal income post-retirement
  • makes maximum pension contribution each tax year.
Retirement Date  31 March 2026 - 2025/26 tax year 30 April 2026 - 2025/26 tax year 30 April 2026 - 2026/27 tax year   30 April 2026 - Total
 Taxable LLP income
 £1,375,000    £1,375,000  £125,000  £1,500,000
 Additional net profits
 £60,000    £20,000  £40,000  £60,000
 Total Taxable Income
 £1,435,000  £1,395,000  £165,000  £1,560,000
 Less: tax & NICs
 (£660,720)
   (£641,920) (£48,133)  (£690,053)
 Less: net pension contribution  (£8,000)   (£8,000)  (£48,000) (£56,000)
           

 Net cash position

 £766,280  £745,080  £68,867  £813,947
 Funds added to pension
 £10,000    £10,000  £60,000  £70,000
 Net income position
 £776,280  £883,947
 % income retained
 54.10%  56.66%
 Tax saving (£1,435,000 x 56.66%) - £776,280        

 £36,838

In the above scenario, a 30 April retirement date has the following impacts:

  • a tax saving of £36,838 based on the same profit/income as at 31 March, due to the profit/income now being subject to lower tax bands
  • an opportunity to make an additional year of pension contributions and receive tax relief
  • cash benefit of an additional month’s income that will likely not be available if retiring on 31 March
  • cashflow saving related to the deferral of tax on additional net profits accelerated (six-month deferral).

When should a partner retire?

As can be seen, despite the perceived simplification of basis period reform, the question of when to retire for tax purposes is still relevant. Taking appropriate advice could lead to:

  • an overall tax saving
  • deferred tax payments
  • increased pension capacity
  • no unexpected tax liabilities
  • assessment whether appropriate tax reserves are held (only applicable if partnership reserves for partners tax liability).

For those partners thinking of retirement over the next few years, it is never too early to start tax planning for your retirement. If you would like help with such planning or wish to discuss this topic further, please do speak with your usual Crowe contact.

Insights

From 6 April 2023, partners in firms which do not have a 31 March or 5 April year end will be subject to a new basis of taxation.
What impact will basis period reform have on those affected?
What impact will basis period reform have on those affected?
From 6 April 2023, partners in firms which do not have a 31 March or 5 April year end will be subject to a new basis of taxation.
What impact will basis period reform have on those affected?
What impact will basis period reform have on those affected?

Contact us

Alex Conway
Alex Conway
Partner, Professional Practice and Private Clients
London