With all the talk of pension simplification and its effect on approved (soon to be called registered) pension schemes, I thought it might be worth a look at the often overlooked world of unapproved schemes (soon to be called employerfinanced retirement benefit schemes) and how they will be affected by the changes from April 2006. Before looking at the proposals, it is worth reminding ourselves of the current position for unapproved schemes.
As I have said on many occasions, once it is accepted that an approved pension arrangement is, in effect, a tax-effective wrapper for investments which, in return for tax benefits, imposes conditions regarding the level, form and timing of benefits, it is easier to consider the alternatives. Quite simply, the alternatives for most people comprise any unapproved funded or unfunded pension arrangement and the complete range of non-pension investments available. A list might look like this:
Funded unapproved retirement benefit schemes (Furbs) – onshore and offshore.
Unfunded unapproved retirement benefit schemes (Uurbs).
Collective investments including unit trusts, investment trusts and open-ended investment companies – onshore and offshore.
Insurance investments (qualifying and non-qualifying) – onshore and offshore.
Wrap platforms holding all or any of Isas, collective investments and insurance investments, as well as approved pensions.
For a business owner, their own business.
Direct or pooled investments in property.
Venture capital trusts and enterprise investment schemes.
Many other investment types might also be included. Each has its own mix of risk, reward, accessibility, form of benefits and tax treatment.
Under current legislation, the main reasons for individuals considering alternatives to approved pensions include:
The pension cap preventing further contributions.
Disaffection with annuity income.
Desire for greater flexibility.
Desire for greater access to funds.
Desire for all the accumulated benefits from the investment to be available in cash.
Desire to ensure that any funds built up are not lost to the investor's family on death and, if possible, are free of inheritance tax.
Of course, some of these objections will be overcome or soften considerably after simplification although lack of access to funds ahead of retirement will remain a problem.
Subject to the impact that these forthcoming changes may have, for many higher earners and high-net-worth investors it may well be that a combination of approved and unapproved pensions plus less constrained investments will offer a more desirable and appropriate overall solution.
As indicated above, business owners may have a belief that the sale of their business share will deliver the means of providing financial security in retirement. In many cases, however, the perception that the sale of the business share will yield sufficient to sustain a financially healthy retirement will be outweighed by the reality of the business sale not materialising or not yielding sufficient cash – if a sale can be made.
Finally, there is the growing belief that investment in property will represent the best means of securing financial security in retirement.
I will look at these in more detail later. Once again, I stress that this review is by way of setting the scene. It is essential that before taking or refraining from any action, full account is taken of the changes to be introduced from A-Day.
A typical structure for a Furbs will usually be a trust similar in style and format to an approved scheme. This splitting of legal ownership (vested in the trustees) from beneficial ownership (vested in the members) and complete alienation of funds from the employer can offer:
Member comfort and security.
Substantial employer control as a trustee.
Protection from creditors, subject to the usual constraints, Alignment with any approved scheme benefits.
There is no statutory right to deduct a contribution to a Furbs from profits otherwise subject to corporation tax. Section 76 FA 1989 sets out the circumstances when a contribution to a Furbs will not be deductible. A contribution to a Furbs will not be deductible unless the contribution is also assessable on the member under section 386(1) ITEPA 2003. This is the first hurdle to overcome in the race for deductibility. The next hurdle comes in the shape of the need to prove the expenditure is:
A revenue as opposed to a capital expense.
Incurred wholly and exclusively for the purposes of the trade.
Not otherwise excluded from being deductible.
The greatest risk of non-deductibility comes where the member is a significant shareholder in the contributing company. But there appears to be little evidence of non-deductibility having been a problem in practice. I certainly am not aware of this. Section 386(1) (formerly section 595(1)(a) ICTA 1988) ITEPA 2003 specifically provides for an employer contribution to a Furbs to be assessable in full on the employee.
If there is more than one member of the Furbs, the contribution must be split among them according to their prospective benefits. Contributions are now subject to NICs.
Amounts assessable on members by virtue of employer contributions would usually be pensionable. Direct member contributions should not be made as this could trigger adverse tax treatment of income and gains made by the trustees.