My company is cash-rich and I want to explore ways of extracting money that do not involve increasing my own substantial pension provision. What would you advise?
You have a substantial executive pension fund in your own right. There is scope to add further contributions but the potential corporation tax and National Insurance savings that this route offers your company are, to a certain extent, offset by the certainty that you will be unable to increase the amount of tax-free cash available to you and your pension income in retirement will be subject to higher-rate income tax.
We therefore need to consider alternative means of extracting funds from the company. I still think that pensions remain a viable option, given that your existing provision, while pushing you into higher-rate income tax, still falls far short of the income you take from the company while working.
You should consider instead creating a pension for your wife. Your wife is a 50 per cent shareholder of your company and has been an employee since its foundation. Importantly, she has never been a director and, therefore, would not be treated as a controlling director for pension funding and maximum benefit purposes.
She has no previous pension provision in her own right, apart from state benefits, and few other income-producing assets to support the family income after retirement. Your wife is somewhat younger than you but, given that you are central to the activities and profitability of your business, she will be retiring at the same time as you in five years.
Your wife does carry out work for the company and she receives a modest basic salary just above the lower earnings limit for National Insurance purposes to ensure that she builds up state pension benefits. The balance of her income is paid in the form of dividends. If you were to maintain her annual salary of £5,000, then the company could pay £3,600 into a personal or stakeholder pension for her immediately. While the company cannot backdate contributions across a financial year, your wife could pay £3,600 to the pension for 2003/04. Assuming no changes to income or allowances, the company could then pay a further £14,400 to the personal pension until she is 60, when she plans to retire and draw benefits, adding up to a total contribution of £18,000 from the company.
Perhaps a better route would be to use an executive pension plan conforming to occupational pension scheme legislation and using defined-benefit rather than defined-contribution maximum funding rules. Using the same salary, your company could contribute £18,815 immediately and £33,136 over the same five-year period.
There is also scope to adjust your wife's remuneration, paying her salary instead of dividends for some of the time. While paying a higher salary and establishing a basis year would be possible for a personal pension, the same is not true of an occupational pension scheme. However, given that we are only planning over five years, you could pay your wife the following amounts: years one and four £30,000, years two, three and five £5,000 or the lower earnings limit plus £5 if higher. This would allow the company to contribute £112,891 to the executive pension plan immediately and a total of £198,815 over five years. Assuming 7 per cent annual investment returns, the pension fund at age 60 would amount to £255,000.
Your wife would not be treated as a controlling director, so you can use the more flexible definition of final pensionable salary being: “Remuneration (on which schedule E income tax liability has been assessed as final and conclusive) for any one of the five years preceding the normal retirement date. Remuneration includes basic salary for the year in question together with the average of fluctuating emoluments, such as bonus or commission, earned over a period of three consecutive years ending in the year in question.”
When your wife comes to take her pension benefits, we simply elect her pension to be based on her basic salary in 2004/05, being one of the five years preceding her normal retirement date, and increase the salary in line with inflation over the intervening period (called dynamisation), allowing her to take a tax-free cash sum based on a £30,000 salary plus inflation, despite having received this amount only twice since she started service.
Our understanding of the Government's pension simplification rules suggest that your wife could take 25 per cent of the resulting fund as a tax-free cash sum after April 6, 2006, resulting in the following; Your company will invest £161,040 net of corporation tax into a pension fund for your wife. She will receive £63,750 tax-free cash and is still left with a pension fund of £191,250 to use to create a retirement income which would be subject to income tax at the lower rate.