The idea of a pension is to save money in times of higher earnings. This allows saved funds to grow in a tax-free environment allowing the funds to be used in retirement when income and related tax is lower. Some refer to this as ‘Exempt, Exempt, Taxed.’ In effect the tax point of a career’s worth of earnings is spread over a longer period. This can bring the joys of compounded investment returns as well as significant tax benefits. For owner-managers, pensions represent a significant tax-saving opportunity.
In simple cases, an employee can make significant individual pension savings up to the Annual Allowance of £60,000 (2023/24) per annum, deducting the gross amount from their taxable earnings in the tax year the contribution was paid. Higher earners are subject to a taper, but the relief does not drop below £10,000. It is more efficient for National Insurance if the employer makes the payment, perhaps by way of salary sacrifice which still works for pensions.
For most employed individuals, their own contribution will be limited by affordability or their earnings. Where a family company is involved, and there is a desire to make significant employer contributions, the main limitation is often the individual’s Annual Allowance (AA) cap. When contributions exceed the limit (AA plus unused relief brought forward), there is potentially an income tax charge on the individual at their marginal rate. Therefore, pension planning should be undertaken with the benefit of expert professional advice.
In order to be deductible against Corporation Tax for any particular accounting period, the pension contribution must be paid and incurred entirely for the purposes of the trade. This means that the whole remuneration package for directors, including pension contributions paid, must be considered.
Operating a Small Self-Administered Pension Scheme (SSAS) gives an interesting opportunity to grow a savings fund up to a level where it can invest in businesses trading premises. Once the fund has reached critical mass, the SSAS may invest in commercial property and lease it to the trading business. There will be legal costs as the rent will need to be formalised in a lease. The rent paid will be Corporation Tax deductible in the company and will be a tax-free receipt by the pension fund. This opens the way for excellent investment returns in the pension fund. Pensions funds can even borrow for this purpose, though only to a limited extent. The pension fund growth represented by property appreciation is also Capital Gains Tax free.
Any purchases of trading property are chargeable to Stamp Duty Land Tax. If the acquisition is from the owner or the trading company, it must be at market value and there may be Capital Gains Tax to pay on the sale to the pension fund.
Depending on the number of members, building SSAS fund to a substantial sum sufficient to make a property investment is a medium-term strategy from a standing start.
When considering pensions, every individual currently has an upper amount of capital value which attracts tax relief. If an individual’s savings exceeds this amount there are additional taxes (Lifetime Allowance Charge) which apply to the excess capital when funds are withdrawn. These additional charges are generally considered harsh and are to be avoided. The lifetime allowance is £1,073,100 for 2023/24 after which it is expected to be abolished. Despite the abolishment, new similar rules are likely to be introduced in due course. Those who expect their pension savings to reach anywhere near this, including expected future growth to the target retirement date, will need consider suspending contributions and look at other savings such as ISA.
The main reason for pension savings is to provide income in retirement. However, pension funds can have an important alternative role in life assurance and wealth planning. Under current rules a pension fund held in trust does not form part of a person's estate and may therefore be considered an Inheritance Tax (IHT) advantaged asset.
Some individuals see their IHT analysis transformed on a successful business exit. They may find they become capital rich overnight with no realistic requirement to ever draw their pension at all. In these circumstances individuals might consider the pension death benefits which can effectively be passed to nominees free of IHT by a process of expression of preference. This method allows unused drawdown funds to be passed to a wide range of individuals beyond dependents.
For more information on the topics addressed in this article or to discuss your specific circumstances, please get in touch with Simon Warne or your usual Crowe contact.