I read that Chancellor Gordon Brown in his Budget did not alter any of his proposals for applying penal taxes on the death of people in alternatively secured pensions. My wife and I are over age 75 and in Asps. Do you have any suggestions on how we should move forward?
Budget note 19 not only confirmed that Gordon Brown is going ahead with his penal tax charge but confirmed that the principle of tax relief on pensions contributions is “to produce an income in retirement and is not a mechanism to accumulate tax relief capital that can be passed over on death”. What we now have to look at is how to use your pension fund to generate the maximum income during both your lifetimes and then how we can use that income most efficiently.
Through your own success, you now find that you do not need to take the income from your pension fund as you have sufficient income elsewhere. Unfortunately, if you do not take anything from your pension fund and live beyond age 75, you stand to lose 82 per cent of that fund in taxes.
Interestingly, one solution utilises existing legislation and regulation as a way forward. Regardless of our views of the Chancellor and his tax policy, a 40 per cent higher-rate income tax is not excessive in European terms. As you do not need the income, having an excellent standard of living at the present time, I recommend that you now move to the maximum unsecured pension for you both. This income will be taxed at 40 per cent.
Under existing inheritance laws, you are able to make gifts to others without incurring any inheritance tax liability if, in simple terms, the gift is out of income on a regular basis and does not alter your standard of living. This does not replace other exemptions and does not create a potentially-exempt transfer as long as these gifts are documented properly. This will involve meetings with your solicitor and accountant. So one solution is to take maximum income, pay 40 per cent tax and then give it away to your family or others. Forty per cent tax is better than 82 per cent tax.
Stakeholder pension legislation introduced several years ago allows anyone to make a pension contribution for anyone else up to £2,808. This is the net equivalent contribution of the maximum £3,600. So you could make pension contributions for your five grandchildren of £2,808, which would be grossed up with basic-rate relief, meaning that they effectively receive back 22 per cent tax relief on the contribution in the form of an increased pension contribution.
The end result is that you have paid 40 per cent tax on your pension but they have received 22 per cent back in the form of an increased pension contribution.
You can actually go further if you wish and make pension contributions for your children.
The new contribution limits for pensions mean that substantial contributions can be made in most cases for an amount up to the earnings of the child. Naturally, we would have to take into account any pension contributions they may pay themselves. So if you paid a further £10,000 net contribution for each of your two children, this would be increased by £2,820, being paid into their pension scheme by the Revenue. As they are both higher-rate taxpayers, quite incredibly they will be able to claim higher-rate tax relief on the grossed-up £12,820.
In effect, the 40 per cent tax that you have paid on your pensions is reclaimed in the form of an increased pension contribution and higher-rate tax relief for your two children.
A great deal has been written about recycling tax-free cash but nothing about recycling pensions. You can pay a further pension contribution for yourself and obtain 22 per cent gross-up on the contribution but then claim higher-rate tax relief yourselves. There are restrictions relative to the pensionable earnings you both continue to receive but this would mean that more pension funds could be built up from which you can take your 25 per cent tax-free cash.
No matter what we think about Gordon Brown and his prospects of being Prime Minister, or the result of the next general election, legislation will be in place very shortly which will mean that anyone dying after age 75 risks losing most of any remaining pension fund in tax.
To not draw down the maximum income now in the hope that there may be a change in Government. which may then change this law, has to be a highrisk strategy.
I believe that your best way forward is to maximise the income from your pension scheme, relative to its investments, and then decide how you are going to use this additional surplus income.
Richard Jacobs is managing director of Richard Jacobs Pensions & Trustee Services