The problem: The client, Joe, is a 53-year-old who has been building up his small plumbing business. He has never been a member of a registered pension scheme as he has always worked for small plumbing businesses before he set up his own company. Joe has been taking dividends from the business but has not been making any pension provisions. Joe does not want to contribute a large amount into his pension just now but feels he needs some advice now so he can plan for the future.
The solution: Consider making a small contribution now and a much larger contribution in a few years.
Many people like Joe delay starting a pension until they earn more or until they “build up their business”. They want to be more financially secure before committing to pensions saving.
But people who are not currently members of a registered pension scheme, like Joe, are depriving themselves of annual allowance as carry-forward may only be used if the member was a member of a registered pension scheme.
Those putting off saving for pensions can no longer put in significant contributions close to their retirement due to the reduced annual allowance and, prior to vesting due to the removal of the ‘year of retirement’ exemption.
It was previously common for those in Joe’s position to wait until they wanted to retire and then to place large amounts into the pension scheme.
It would be advisable for Joe to make a small contribution now so that when he does feel that he can contribute to his pension, he can then make a large contribution.
As shown above, by joining a registered pension scheme before the end of the current tax year, Joe can make an extra £125,000 in pension contributions, which would otherwise not be allowable if he were to wait until after 6 April 2016.
In 2016/7 when Joe feels able to contribute more to his pension – he can make substantial contributions within a few days. How is this possible?
Pension input period planning can be done in 2016/17 to use the previous three years’ annual allowance in a short period of time.
This works particularly well at the end of a tax year and can generate significant levels of annual allowance.
Using the figures from the graph shown here:
- In tax year 2016/17 Joe has £125,000 of carry-forward available plus £40,000 of annual allowance for 2016/7. He writes a cheque for £165,000 on 31 March 2017 and writes to his provider nominating a PIP end date of 1 April 2017.
- He then writes another cheque for £40,000 on 2 April 2017 and nominates an end date of 6 April 2017. This uses his annual allowance for 2017/18.
- On 7 April 2017 he pays another contribution for £40,000 and nominates the PIP end date to be 6 April 2018. This uses his annual allowance for 2018/19.
This means that the total he can input in the space of eight days is £245,000.
This relies on Joe having sufficient earnings to allow relief on this substantive series of contributions, or access to employer contributions or both.
Fortunately Joe is the owner manager and he has access to the company bank account. Making pension contributions is very tax effective for a company as it reduces the corporation tax payable.
This planning strategy also relies on the provider allowing the member to nominate the PIP so Joe’s adviser would need to check if this is possible. This strategy also relies on the annual allowance remaining at £40,000 in 2016/7.
HMRC allows this type of planning because ultimately individuals are caught by the lifetime allowance but from a tax relief/timing perspective this may be useful for high-net-worth individuals’ tax and retirement planning.
Clare Moffat is technical manager at Prudential